If I told investors at the beginning of 2016 that Alphabet Inc’s (NASDAQ:GOOGL) would be getting beaten after 49 weeks of the year by 374 out of the 502 companies in the S&P 500, many of you would have thought I was off my rocker. But that’s exactly where GOOGL stock sits with a few weeks to go left in the trading year.
Alphabet shares were up just 1.7% year-to-date through Dec. 8. “Imagine that,” my mother-in-law would say in her best Maritime accent.
However, if you’ve never owned GOOGL stock, don’t be put off by its lack of performance in 2016. It’s a must-own stock for any investment portfolio.
Here are three reasons why I feel this way.
GOOGL Stock Key #1: “Other Revenues”
You might think that Google is nothing more than a glorified advertising company — after all, 89% of the $76.1 billion in annual revenue Alphabet generated through the end of September came from its ad business — but you’d be mistaken.
In Q3 2016, GOOGL generated $2.4 billion in other revenues, 39% higher year-over-year and 12% sequentially. This represented 10.9% of the Google segment’s overall revenue of $22.3 billion. For the first nine months of the year, Google’s other revenues came to $6.7 billion, 31% higher than a year earlier. There’s nothing insignificant about this kind of revenue. On its own, it would be a decent-sized business.
The two biggest components of its other revenues: Google Cloud and Google Play.
While the advertising revenue generated by Google Play is included in the websites sub-segment of Google, the apps and media content sold in the Google Play store falls under other revenues. With the global mobile app market expected to surpass $100 billion by 2020, Google’s revenues in this area will jump exponentially.
On the cloud side of the ledger, GOOGL has been playing a weak game of catch-up with Amazon.com, Inc. (NASDAQ:AMZN), but the Q3 numbers suggest that’s starting to change for the better.
Keep an eye on this number. As long as other revenues continue to grow as a percentage of Google’s overall revenue, Alphabet’s winning.
GOOGL Stock Key #2: “Other Bets”
The “Other Bets” — not to be confused with “other revenues” — are the various businesses Alphabet owns outside its legacy Google segment. They include Nest, Verily, Access, X, etc. and represent the company’s constant push for innovation.
They’re also big-time money losers.
In the 12 months ended Sept. 30, they collectively lost $3.8 billion. Most of the early stage revenue is generated by Nest (thermostats, CO2 sensors), Access (Google Fiber) and Verily (contact lenses, healthcare analytics).
In the first nine months of 2016, its Other Bets saw revenues increase 85% year-over-year to $595 million, but still less than 1% of the legacy business’s overall revenue.
Innovation, while at the heart of the Other Bets’ DNA, can’t be carried out in a bubble. Profits do matter. When Alphabet was created, entrepreneurial leaders such as former Nest CEO and co-founder Tony Fadell felt hamstrung by a new financial discipline that asked more of its so-called “moonshots.” He left in June.
While that’s temporarily slowed innovation at Nest, ultimately it looks to be the first Other Bets business to actually make money.
As painful as it is for investors to see Alphabet pour good money after bad into its Other Bets, GOOGL stock depends on it. Because its legacy business likely won’t be this profitable 10 years from now.
GOOGL Stock Key #3: Ruth Porat
According to Fortune magazine’s 2016 list of the 100 Most Powerful Women, Alphabet and Google CFO Ruth Porat ranks 13th on this year’s list ahead of some pretty powerful executives.
Porat was hired away from Morgan Stanley (NYSE:MS) in May 2015 after almost 30 years in financial services. With a hard-driving work ethic, she was brought in to bring a new financial discipline to Google helped along by the reorganization of the company’s various businesses under Alphabet, its new holding company parent.
Since taking the CFO job, GOOGL stock is up 45%, or 26% on annualized basis. However, most of those gains came in 2015, because year-to-date it has barely gotten off the ground.
Investors might have cooled on Alphabet stock so far in 2016, but Porat’s focus on expenses has created a free cash flow machine. In 2014. Alphabet had $11.4 billion in free cash flow; today, it’s around $23.5 billion, so more than double. Put another way, Alphabet had a free cash flow yield of 4.6% at the end of 2014; today, it’s 6.2%. Not bad for a company whose capital spending approaches $10 billion annually.
Porat’s critics suggest this focus on expenses strangles innovation. I say poppycock. And so does she.
“As we reach for moonshots,” Porat said in its October earnings call. “it’s inevitable that there will be course corrections along the way to lay the foundation for a stronger future.”
Innovation dies, not because you control cash — but because you run out of it.
A CFO’s main job is to create as much positive cash flow as is operationally possible. Porat does that and then some.
As long as Porat is at the wheel, GOOGL stock is a must-own.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.