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3 Major Risks for Alphabet Inc Stock for Investors to Focus On

The recent plunge in Facebook stock could be ominous for Google stock

By Tom Taulli, InvestorPlace Writer & IPO Playbook Editor
The EU's $5B Ruling Won't Trip Up Google Stock

Source: Shutterstock

Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) stock has lost some of its mojo lately. Just this week the company was knocked off the list as the No. 2 most valuable company. Yes,, Inc. (NASDAQ:AMZN) has taken its place.

What now? Well, I think the bull case on Google stock still looks intact. The fact remains that the company has a set of standout assets, of which seven have over 1 billion users. These include the main Google property, YouTube, Gmail, Maps, Chrome, Android and Play.

What’s more, the core search business continues to remain dominant, accounting for a staggering 90% of the world’s internet searches.

Oh, and yes, the valuation on GOOGL stock is also fairly attractive. Consider that the forward price-to-earnings ratio is 22.5X.

However, this is not to imply that Alphabet stock is not without its risks. Let’s face it, the tech industry is subject to wrenching changes and disruptions.

So then, let’s take a look at some of the most nagging issues.

Google Stock Risk #1: Reliance on Advertising

Over the years, Google has been trying to diversify its business away from advertising, such as with its cloud business and smart speakers. Despite these efforts, ad revenues still account for 70% of the total revenue.

So why is this a big problem for Google stock? One reason is that the ad business is subject to shifts in the economy. For the most part, whenever there is a recession, companies often first cut back on advertising — because it is easy to do.

But there is something else to consider. Google’s is facing much more competition for ad dollars as well. According to a recent report from eMarketer, the company will lose some of its market share this year.

Interestingly enough, the rivals that are putting pressure on Google are not just social platforms, like Snap Inc (NYSE:SNAP), Pinterest and Instagram from Facebook, Inc. (NASDAQ:FB).

Keep in mind that perhaps the toughest competitor is actually Amazon. The eMarketer report forecasts that the company will see a 64% boost in ad revenues in 2018 to $2.89. And by 2020, AMZN is on track to be the No. 3 player in the industry.

But this should be no surprise. For the most part, AMZN’s e-commerce platform is a particularly attractive piece of digital real estate. The company can leverage its purchase intent data to sell high-performing ads.

Google Stock Risk #2: Rising Costs

A big benefit for Google stock is that the company gets huge amounts of free traffic. It’s been a key to the company’s significant profitability.

But there’s a hitch. Some of Google’s key areas, such as mobile, are not free. For example, the company pays substantial fees to Apple Inc. (NASDAQ:AAPL) to be the search engine.

Such fees are included in traffic-acquisition costs (TAC), and they have been steadily rising. In fact, during the latest quarter, it appears that TAC weighed on margins.

This is how RBC Capital Markets’ analyst Mark Mahaney put it: “The negative is expenses came in heavier than expected. That raises a question: How much revenue is this company having to give away to maintain these growth rates?”

He also points out that even small increases in TAC can have a material impact on the bottom line. Based on his analysis, a 1% increase would translate into a 1% decline of his EPS estimate for 2018.

Google Stock Risk #3: Threat of More Regulation

The plunge in FB stock should be a warning to Google stock. Of course, FB has suddenly become embroiled in a major controversy, in which millions of user profiles were allegedly used improperly. Already there are calls in Congress for investigations and potential reforms. The same goes for other countries, especially in Europe.

It’s tough to gauge what the impact may be. But it seems reasonable that there will be increased regulation on the mega operators like FB and GOOGL, which could make it more difficult to monetize the traffic and keep up the growth rates.

True, it may take time for this to happen. But then again, this is likely to mean there will be a cloud of uncertainty over the shares in the meantime.

Tom Taulli is the author of High-Profit IPO StrategiesAll About Commodities and All About Short SellingFollow him on Twitter at @ttaulli. As of this writing, he did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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