I recently wrote an article suggesting that Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) was the perfect value play, as it was a growth stock that was not unreasonably valued based on various criteria. Now I’ll dive into what I think the risks of GOOGL stock are, and how they may manifest.
My biggest concern with GOOGL stock has always been that it is effectively a one-trick pony. Alphabet is the largest digital advertising billboard in the world, with about 88% of its revenues coming from advertising. Moreover, GOOGL stock’s growth has been driven by this spectacular seizure of internet territory from competitors.
In fact, during the financial crisis, ad revenues still grew about 8% year-over-year in 2009 despite a worldwide ad revenue decline of 11% that year.
GOOGL Stock and Digital Advertising
Now, digital advertising was still in its hyper-growth phase back then. Should another major crisis hit, I’m not so sure that Alphabet won’t see a decline. Yet what’s so astonishing about GOOGL stock is just how much money it makes from advertising. It could get hit with a 20% decline in total revenues, which would bring it roughly in line with fiscal year 2015 results, and still generate net income of $15 billion or so, and operating cash flow of $26 billion or so.
This is hardly a catastrophe, which shows that for now at least, GOOGL has a lock on substantial growth in ad revenue. However, that advertising is the result of people using Google’s search engine. What if that changes? Right now, Google has more than 80% search engine market share. It’s so popular that we now use the product’s name as a verb.
I think it will be very difficult to supplant Google as far as search engine usage goes. However, there is other behavior which may result in less reliance on the search engine and, therefore, fewer eyeballs for ads. Mobile apps have obviously exploded in number and usage. The more adept and fully functional that apps become, the less Google may be used.
Social media is only going to grow, and the more that these products offer in terms of either their own search engines, or places for advertisers to divide their ad spend, the worse it is for GOOGL.
There’s also some interesting competition in the form of product searches, and of course, that competition comes from Amazon.com, Inc. (NASDAQ:AMZN). According to a 2016 PowerReviews survey, 38% of users use Amazon as a place to search for products, and Google comes in second at 35%. I think about my own usage when it comes to product searched, and yes, I always start with Amazon. Inventory, price and reviews are the reasons why people start there. The larger that Amazon grows, the stickier it will become as far as product searches, and that could mean fewer eyeballs for GOOGL.
Obviously, Alphabet Inc. has plenty of money and can ramp up competition in mobile access, but Apple Inc. (NASDAQ:AAPL) and Facebook Inc (NASDAQ:FB) obviously have a corner on that market so far.
There is some regulatory risk, as well. The EU slammed Alphabet Inc. for tweaking search results to direct people to its own shopping sites. The FCC is an unknown beast — it could end up regulating the internet in ways harmful to GOOGL stock.
However, when it comes to buying the stock, I don’t see immediate dangers to GOOGL that makes its valuation less attractive. At 18x next year’s earnings, and five-year annualized analyst projections of 19.3% growth, it’s already undervalued. When I give it a 10% premium for global brand name, cash flow and cash on hand, it becomes a true growth and value play. Still.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
