I’ve been skeptical toward Alphabet Inc (NASDAQ:GOOGL) stock for a while now, and, so far at least, I’ve been wrong. The GOOGL stock price has cleared $1,000 for the third time and trades at an all-time high. Google stock is up 28% year-to-date, and up about 50% from July 2016 lows.
My long-running concern with GOOGL stock has centered around its reliance on advertising. This is a company with an enterprise value over $600 billion. The smaller, but highly publicized, initiatives elsewhere don’t really move the needle all that much.
Even if self-driving car unit Waymo is worth $70 billion (and my colleague Brian Wu makes a strong case that such as valuation is far too optimistic) that value supports roughly 10% of the GOOGL stock price. I remain skeptical that doubling down on hardware makes much sense, nor does much for the market value of Google stock. Elsewhere, in cloud, smart home and other areas, Alphabet simply isn’t winning.
I still believe it has to start doing so for GOOGL stock to gain, and I still question whether Alphabet actually will.
Advertising Still Supports the GOOGL Stock Price
In Alphabet’s second quarter, advertising (including from YouTube) drove a whopping 87% of total revenue, and that has to be a concern. It’s worth remembering that only a couple of years ago, GOOGL stock was pressured by fears of declining ad rates and a possible stagnation in the online advertising industry.
Those fears haven’t completely subsided. Most observers believe the online advertising industry is a mess, with billions of dollars in fraud every year. So far, those concerns likely have benefited Google and Facebook Inc (NASDAQ:FB), who at the least have the scale and incentive to root out bad actors. As a result, one report estimates that 99% of US online advertising growth in 2016 accrued just to those two companies.
But both have issues as well. Last month, InvestorPlace columnist Ian Bezek discussed the numerous concerns surrounding Google’s advertising business. Earlier this year, Lawrence Meyers discussed the very real potential of phony traffic on Facebook.
Alphabet’s reliance on online advertising is driving growth for now. But it’s also a very real risk to Google stock in the mid- to long-term. That business is not healthy. And with ad rates still falling, it likely doesn’t drive enough growth to support a still-lofty valuation on GOOGL stock.
Upside to Google Stock Requires Wins Elsewhere
And so I still believe Alphabet needs real, sustainable, significant profits beyond advertising. And we’re not there yet. At the moment, the biggest potential driver for Alphabet earnings is simply reversing the $3 billion-plus ($3+ per share after-tax) in annual losses from the ‘Other Bets’ businesses.
What else drives growth? Waymo isn’t proven and again only supports a portion of YTD gains for Google stock even if more optimistic valuations are correct. Google Fiber has been a disappointment. I’m highly, highly skeptical the Pixel is going to take market share, and Apple Inc. (NASDAQ:AAPL) stock is trading at ~12x forward EPS in large part because of commoditization fears around hardware.
Brad Moon makes a convincing case for Alphabet’s leadership in artificial intelligence, but the best technology doesn’t always win. And Alphabet already is behind in AI products. Google Assistant is behind the Amazon.com, Inc. (NASDAQ:AMZN) Echo. Cortana from Microsoft Corporation (NASDAQ:MSFT) has huge reach elsewhere through the installed base of Windows and Office products.
Google’s Nest hasn’t made the headway many thought. Google Cloud is behind Microsoft and Amazon. There’s a lot of evidence that suggests that Google, beyond advertising, isn’t a top-tier company. And yet GOOGL stock is getting a top-tier valuation, at least for a company of its size.
Better Options Elsewhere
Alphabet still has time to start gaining share in some of its newer categories. The balance sheet is full of cash and long-term artificial intelligence, ‘big data’ and other trends might be enough.
But to get too excited about Google stock, or to forecast the Google stock price reaching $2,000 years down the line, I still think Alphabet Inc needs to start winning more beyond advertising. And, at the moment, I’m not seeing nearly enough to be confident that will happen.
As of this writing, Vince Martin has no positions in any securities mentioned.
