When it comes to Alphabet Inc (NASDAQ:GOOGL,NASDAQ:GOOG), I’ve been mostly skeptical — and mostly wrong. Alphabet stock has gained 33% in the last year and doubled over the last three.
Of course, GOOGL hit some turbulence earlier this month — not long after I predicted a strong fourth-quarter report. Alphabet stock ran into a double whammy, with a disappointing Q4 report coming at the same time as a major market pullback. GOOGL would drop a whopping 201 points — almost 17% — in just nine sessions between January 29 and February 9.
As the market has normalized, however, so has Alphabet stock, which has posted a nice 13% bounce. At these levels, however, my skepticism returns.
There’s still a lot to like, admittedly. Investorplace.com’s Tom Taulli laid out a solid bull case for GOOGL just last week. I don’t see Alphabet stock as a short by any means. But Q4 results reflected some of the concerns I’ve had for a while here. And I’m not sure just how much upside GOOGL really has left.
Alphabet Stock’s Advertising Problem
My largest long-running concern with Alphabet is its heavy reliance on advertising. Per the 10-K, over 86% of total revenue was derived from advertising in 2017. That’s only modestly lower than the 88% seen the year before.
Concerns about that business model drove the post-Q4 sell-off. Notably, TAC (traffic acquisition costs) spiked 33% year-over-year. CPC (cost per click – basically pricing) declined 14%. That pressured profits, one reason for a decently-sized earning-per-share miss relative to Street estimates.
To be sure, these concerns are offset by 43% growth in paid clicks. It’s not as if Google’s advertising profits are declining. And with mobile still driving much of the directional moves in both TAC and CPC, it’s worth remembering that these concerns have been around for years. What was then still called Google stock barely moved for the first two years of the decade. Investors were worried that the shift to mobile usage, with its much smaller real estate, would lead to much slower growth.
Alphabet stock, of course, has more than tripled since then. Facebook Inc (NASDAQ:FB), dogged by similar mobile worries, is up 900%+ from its all-time low set in September 2012.
Still, it’s worth keeping an eye on the advertising business. Microsoft Corporation (NASDAQ:MSFT) browswer Bing has gained market share. Google’s own Chrome browser now is offering ad blocking, in response to features from other rivals. YouTube faced a sponsor boycott after putting ads next to questionable content, with Roku Inc (NASDAQ:ROKU) among the companies aiming at taking that online spend from major multinational operators.
Other Bets and Alphabet Stock
Add to that potential regulatory pressure, competition from Amazon.com, Inc. (NASDAQ:AMZN), and a general maturing of the online ad market and I’m simply not that excited about Google’s long-term growth potential. There’s going to be some growth — but maybe not enough to get Alphabet to the trillion-dollar market cap level, which at the moment would require another 30% upside.
And I’m still skeptical the rest of the business is quite enough. On the Q4 conference call, CEO Sundar Pichal said the company believed Google Cloud Platform “is the fastest-growing major public cloud provider in the world.” But the approximately $1 billion per-quarter run rate — disclosed for the first time on the Q4 call — still puts the company behind not only Amazon and Microsoft, but International Business Machines Corp. (NYSE:IBM) and Oracle Corporation (NYSE:ORCL) as well.
Self-driving unit Waymo is a gem, no doubt. But will adoption be quick enough to matter in the context of a nearly $700 billion enterprise value? The hardware business isn’t moving the needle, either.
Bottom Line on Alphabet Stock
Alphabet remains an advertising-based business — and that is a real risk here. It’s dominant in advertising — but it’s not elsewhere. And what increasingly look like secular shifts — more mobile usage, distrust of online advertising, concerns about the data held by “Big Tech” — are going in the wrong direction.
To be sure, Alphabet stock prices in some of those concerns. The “Other Bets” segment lost over $3 billion in 2017, a $5 per share headwind to EPS. Relative to “true” earnings power, a forward multiple of about 25x (excluding cash on the balance sheet) probably is closer to the low 20s, or even 20x.
But to be the big winner in big tech — to be the first to $1 trillion — Alphabet stock still needs quite a bit of growth. And the Q4 report raises real worry as to whether that growth will come.
As of this writing, Vince Martin has no positions in any securities mentioned.
