Even Warren Buffett makes mistakes. The Oracle of Omaha admitted as much earlier this year with regards to technology companies, singling out Alphabet Inc (NASDAQ:GOOGL). Buffett averred, “I had plenty of ways to ask questions, or anything of the sort, and educate myself… But I blew it.” Still, the opportunity in GOOGL stock remains.
Feeling that he didn’t have an advantage in the sector, Buffett passed on the investment. You don’t have to make the same mistake.
While the share price has soared, GOOGL stock’s valuation still look reasonable given the double-digit growth across most of its businesses and the stabilization of margins. The ad machine continues to hum along, deepening its moat as it leaves competitors in the dust.
GOOGL’s Virtuous Cycle
While talk of virtuous cycles and flywheels abound, not just in the world of tech, Alphabet is the epitome of such a cycle, spinning vigorously with earnings growth that is unreal in a 1-2% GDP growth environment. More on that in a moment.
GOOGL now has over 2 billion monthly active Android users (MAU). While Apple Inc. (NASDAQ:AAPL) hasn’t disclosed a similar figure for iOS, many make assumptions off the 1 billion iOS devices in active use reported at the time. It’s not apples to apples, but Android has likely exceeded iOS in the MAU count. The other services in the GOOGL ecosystem, seven of which have at least a billion users in their own right, powerfully reinforce user engagement.
The sheer size of that base gives GOOGL significant advertising leverage. Prime examples of improving monetization are the changes in YouTube ads and the introduction of YouTube Red. With more than 1 billion hours of video watched on this platform every single day, advertisers are keen to get in front of a targeted audience. Alphabet is more than capable of doing just this.
Monetization improvements across its business units will drive cash flows, which in turn give GOOGL the ability to invest further in its core services to ensure that they are best-in-class and develop new products. With all the investment in talent and infrastructure required to develop such a sticky ecosystem filled with high-quality services, the barriers to entry increase dramatically as time passes.
These forces at work serve to deepen and widen GOOGL’s moat. The end result will be oligopolistic, if not monopolistic, as the company that amasses scale and finesses monetization will gobble up most of the pie and capture any new slices that emerge.
To wax on about network effects is all fine and good, but ultimately the test to see whether or not a company is truly reaping the benefits of such effects lies in the numbers.
First-quarter earnings were incredibly strong with both revenues and operating cash flows up over 20%. Q2 earnings were similarly strong despite the European Commission fine. Year-over-year advertising revenues continued skyward, up 18%. And Other Bets, the segment filled with immense potential, was up 34%.
Though the operating losses in Other Bets have been decreasing, they are still in the hundreds of millions.
The benefit of having such a strong balance sheet is that Alphabet can afford to make calculated bets on transformational technologies. The risk/reward is unclear in this segment but the potential to create a truly disruptive service is huge. The probability of such a thing happening is high when you attract the finest minds in tech.
With margins steady and double-digit growth across a number of its products, GOOGL stock’s 34x-plus multiple may still be too expensive for Buffett but by no means expensive on a relative basis, especially when compared to other FANG stocks.
As of this writing, Luce Emerson did not hold a position in any of the aforementioned securities.
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