The secret of Alphabet (NASDAQ:GOOGL) stock success is simple.
As it prepares to announce another grand quarter on Feb. 1, with net income of $26.69 per share and revenue of $59.3 billion expected, I’m here to tell you that secret. It’s a hardware company.
GOOGL stock rose to prominence on Google search software, but its continuing success is based on owning hardware.
I’m not just talking about Android phones or Chromebook PCs, which like Microsoft (NASDAQ:MSFT) set standards for other OEMs.
The secret sauce of Alphabet is Google’s cloud data centers. They are now in 29 locations around the world, with 9 more on the way.
It’s in filling these centers with content it doesn’t pay for and cloud data that pays to be there, that Alphabet makes its money.
It sells ads against other peoples’ stuff. Its ambition is to have companies pay to keep their stuff with it.
A Closer Look at GOOGL Stock
Between them, Alphabet’s Google and YouTube video unit drew over $53 billion in revenue, just in the third quarter. Google search ads drew $38 billion of this total. Search, YouTube, and its ad network are all growing at 40% per year and more.
The traditional model for ads was that you paid to create content people looked at. Ads acted as billboards on the side of that road. Alphabet’s Google search isn’t creating any content, only metadata.
This is data about data, like where it is and what or who it’s connected to. Alphabet is selling ads against that.
This has systematically killed the business model for most content. Newspapers and magazines are dead. TV is dying.
Why should an advertiser pay production costs when they can get the same benefit sitting next to a search query, or some kids’ cat video? Especially since the metadata knows who’s making that search query, or looking at that cat?
There are many free social and network services. What’s unique about Alphabet (along with rival Meta Platforms (NASDAQ:FB)) is that it owns the hardware on which these services run.
The $6.8 billion in capital it spent expanding its network in the third quarter took just a small piece of its $23.7 billion in operating cash flow.
This is what makes Alphabet and Facebook “Cloud Czars.” It’s the ownership of hardware, paid for with cash flow, that makes them different from social media stocks like Twitter (NASDAQ:TWTR), ByteDance, Snapchat (NASDAQ:SNAP) or Reddit.
Owners don’t pay rent.
Profits from advertising also subsidize Alphabet’s Google Cloud.
As Alphabet’s third-quarter report makes clear, Google Cloud is still losing money, $640 million in the most recent quarter.
The excuse is that it’s growing, by 44% per year, slightly faster than the ad business. Rivals Microsoft and Amazon.Com (NASDAQ:AMZN), by contrast, make money on their clouds. AWS’ profit of $4.83 billion nearly equaled Google Cloud’s total take.
If you’re buying GOOGL stock today, and after talking it down for a year I’m tempted, it’s because you expect Google to eventually make a profit renting cloud space, and to keep growing in the advertising space.
The Bottom Line on GOOGL Stock
The risk in GOOGL stock is the same as the risk in Ford Motor (NYSE:F). It must buy chips in vast quantities to keep growing. New chip factories from Intel (NASDAQ:INTC) and Taiwan Semiconductor (NYSE:TSM) can’t come on-stream fast enough. The cheaper its chips, the less capital it spends, the fatter its profits.
Assuming it can keep buying hardware to monetize, Google practically runs itself. Only in the money-losing cloud operation does it need sales help.
On the date of publication, Dana Blankenhorn held long positions in GOOGL, MSFT, AMZN, TSM and INTC. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Dana Blankenhorn has been a financial and technology journalist since 1978. He is the author of Technology’s Big Bang: Yesterday, Today and Tomorrow with Moore’s Law, available at the Amazon Kindle store. Write him at email@example.com, tweet him at @danablankenhorn, or subscribe to his Substack.