I’ve been bullish on the shares of global technology titan Alphabet (NASDAQ:GOOG) all year long. See this column, this column, and this column. That bullishness has been on target. In 2019, Alphabet stock is up an impressive 30%, marking its fourth best annual performance of the decade.
But going into 2020, I’m less bullish on Alphabet stock, as I’ve become more cautious on the name.
That is, while I think GOOG stock can and will head higher in 2020, I don’t think Alphabet stock can climb that much. I believe that the shares will rise less than 10% over the next 12 months.
Alphabet’s near-term challenges in the digital ad and cloud markets are escalating. Until support arrives from its new growth businesses like Waymo, these headwinds will depress the company’s profit growth. and the company’s new growth businesses won’t start meaningfully contributing to its bottom line in 2020.
Meanwhile, GOOG stock has had such a great 2019 that it doesn’t have too much room left to run in 2020. In other words, the valuation of Alphabet stock looks somewhat maxed out, considering its relatively depressed profit growth outlook.
Alphabet stock will grind higher in 2020 because it’s a long-term winner and its core business has healthy positive catalysts. But it won’t head that much higher because its core business will have some problems, and the valuation of GOOG stock presently ignores those upcoming problems.
Alphabet stock isn’t a bad investment at this point, but it’s not great, either. Long-term investors who are looking for stability should stick with GOOG stock. But those looking to beat the market in 2020 should park their money elsewhere for the time being.
Alphabet’s Growth Outlook Is Good, But Not Great
There are two issues with Alphabet stock heading into 2020. The first is that the core Alphabet growth outlook today is good, but a far cry from great.
On the good side, Alphabet is still the biggest player in the double-digit-percentage-growth digital-advertising market. It’s poised to maintain that status for the foreseeable future because Google search is the backbone of the internet, and YouTube is a hyper-growth business powered by positive, non-cyclical digital video engagement and ad trends.
At the same time, Google Cloud is a very big and relevant player in the high-growth cloud-infrastructure market. The growth of that market should increase in 2020 amid easing trade tensions which should result in higher corporate capital spending.
Over the longer term, Alphabet stock can also get huge boosts from cloud gaming with GOOG’s Stadia product, from self-driving with Waymo, and from the smart home sector with Alphabet’s Nest brand.
But on the negative side, Alphabet has been consistently losing share in the global digital ad market for several years, according to eMarketer. That is because of stiffer competition, a shift towards mobile, where Alphabet is less dominant, and a shift towards social media, where Alphabet has no presence, other than YouTube.
At the same time, Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN) are stealing all the thunder in the cloud infrastructure market, while Google is increasingly turning into a third wheel in that market.
Also of note, Alphabet’s operating margins have been falling for the better part of the past five years, as the shift to mobile advertising has resulted in lower click-through rates, higher traffic acquisition costs, and lower margins. Most, but not all, of the shift to mobile is over. So Alphabet’s margins will still be pressured in 2020, keeping a lid on Alphabet stock.
Alphabet Stock Appears to Be Fully Valued
The second problem with Alphabet stock is that its shares seem to be priced for great, not good, results.
Just look at the numbers. The lion’s share of Alphabet’s revenues come from the digital-ad business. That business has gone from steadily increasing 20%-plus annually over the past few years to climbing 15%-17% in 2019. Its growth will continue to slow because positive digital-ad drivers are easing, and Alphabet’s market share is under pressure from stiffer competition. So the company’s ad revenue will rise 10%-15% per year through 2025.
Alphabet’s “Other” segment, driven today mostly by Google Cloud, has largely sustained 30%-plus annual revenue growth over the past few years. Google Cloud will keep growing. But its growth will slow as the cloud infrastructure market matures and the unit’s growth drivers ease.
It’s hard to predict exactly how much revenue Alphabet’s newer businesses like Waymo and Stadia will generate in the long-run. But, assuming they together generate several billions of dollars of revenue per year, then Alphabet’s “Other” segment should sustain 20%-plus revenue growth through 2025.
Putting those two together, Alphabet’s top line looks poised to climb by low-teen-percentage levels through 2025. Its operating margins should improve during this stretch, driven by mobile ad margin issues fading and the margins of its new businesses expanding as they grow. But Alphabet also operates in intensely competitive and research-heavy industries, so its margin expansion won’t be that significant.
Mid-teen revenue growth on top of mild margin increases make profit growth of around 15% seem achievable. Under these assumptions,Alphabet’s 2025 earnings per share could come in at $100. Based on a price-earnings multiple of 21, which is average for information technology stocks, and a 10% annual discount rate, that equates to a 2020 price target for Alphabet stock of roughly $1,430.
That’s just 6% higher than where Alphabet stock trades hands today.
The Bottom Line on GOOG Stock
Over the long-term, I like Alphabet stock. It’s a great addition to any long-term growth portfolio. But, here and now, I’m not a huge fan of Google stock. I think that GOOGL stock is fully valued. This full valuation, coupled with slowing revenue growth and eroding margins, will ultimately limit the advances of Alphabet stock over the next year.
As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.
