Up front, I’ll admit I’ve been too cautious so far on Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG). I’ve been skeptical of the stock, only to watch the GOOGL stock price climb 32% this year and clear $1,000 for the first time.
Truthfully, my opinion hasn’t changed all that much this year, though the market clearly disagrees. I think there is some intriguing value in the company’s “Other Bets”, including the autonomous driving unit Waymo. But the company’s reliance on advertising looks dangerous, and its track record outside that space simply isn’t that impressive.
Not all that much has changed, really. Advertising accounted for 88% of revenue in 2016, according to the company’s 10-K. The proportion is 89% through the first three quarters of 2017, per Alphabet’s 10-Q. I still see risk to that revenue stream — and not enough strength elsewhere to support a market cap that is nearing $750 billion.
Again, the market has ignored these arguments so far and, admittedly, the GOOGL stock price isn’t exactly extreme on an earnings basis. But I still believe that GOOGL stock will again dip below $1,000 and I still see better plays out there in large-cap tech.
But outside of search, Android and the brilliant 2006 acquisition of YouTube (for just $1.65 billion — less than one-tenth of the current enterprise value of Snap Inc (NYSE:SNAP)), Alphabet hasn’t had a ton of success. In-home hardware offerings — Nest thermostats and cameras, Google Wifi and Google Home — aren’t dominating the market. In fact, Netgear, Inc. (NASDAQ:NTGR) has better market share in both cameras and routers, and the Echo smart speaker from Amazon.com, Inc. (NASDAQ:AMZN) is well ahead of Google Home.
Elsewhere, the Pixel 2 release came with a lot of buzz, but, as BGR reported earlier this month, prices already have been slashed. One estimate earlier this year suggested that Waymo was worth $70 billion, but InvestorPlace contributor Brian Wu questioned that figure back in June, and I’m inclined to agree. Even at the high estimate, the self-driving car opportunity justifies less than 10% of the current GOOGL stock price.
Alphabet is dominant in search and dominant in mobile, outside the Apple Inc. (NASDAQ:AAPL) ecosystem. That alone is enough to make the company extremely valuable. But given the potential challenges in even those dominant areas, I’m still skeptical it’s enough to support an enterprise value of ~$630 billion.
The Risks in Advertising
There ares two broad risks to Google’s advertising business. The first is the increasing advertiser unease with YouTube. Earlier this year, major multinational advertisers boycotted the platform, concerned about their brands being placed next to extremist and/or hateful content.
The issue has raised its head again, after an investigation showed inappropriate videos of minors on the platform — again, with ads for major brands in close proximity. Multiple major companies, including Mars, adidas AG (ADR) (OTCMKTS:ADDYY), HP Inc (NYSE:HPQ) and others have frozen their spending on YouTube as a result.
In response, YouTube is hiring 10,000 new reviewers — at an annual cost in the hundreds of millions of dollars — to remove “problematic content.” But there has to be a question as to whether even that will work. There is a risk, however small, that a user-generated platform simply can’t co-exist permanently with brand-conscious major advertisers. And the platform’s efforts to drive its own original content simply send it headlong into a hugely competitive, expensive space already dominated by Netflix, Inc. (NASDAQ:NFLX).
The second risk is on the search side. Complaints about and fear of “click fraud” and other deceptive practices permeate the online advertising industry. Ad-blocking provides another risk for content creators — and for Alphabet’s ability to help monetize that content. So far, Alphabet and Facebook Inc (NASDAQ:FB) likely have benefited from those concerns, by being the “trusted” operators in the space. But if Alphabet can’t get its content under control, that may not be the case for long.
The GOOGL Stock Price Looks Expensive
These risks might seem minor in the context of still-strong growth and a cheap multiple (GOOGL stock trades at about 22 times 2018 earnings-per-share, backing out its huge net cash pile). But they’ve raised their head before.
Concerns about plunging ad prices — still an issue — kept the GOOGL stock price flat for about two and a half years at the beginning of the decade. There’s nothing that says that sentiment won’t return. And, if it does, GOOGL very well could drop back into the triple-digits.
I still believe that outcome will be on the table at some point. The optimism around Alphabet stock centers so much on its opportunities beyond advertising. But this is a company that simply hasn’t capitalized on those opportunities so far. And if that continues, and advertising can’t pick up the slack, GOOGL stock will have a good ways to fall.
As of this writing, Vince Martin has no positions in any securities mentioned.