Trivia: What AdTech platform grew by 41.2% during 2021?
- Snap (Snapchat)
- Meta (Facebook)
- Alphabet (Google)
Ding, ding, ding! The answer is #3, Alphabet, Google’s parent.
The growth rate seems truly astonishing and here’s why. It’s one thing for a small up-and-coming company to grow revenues by north of 40% annually. Indeed it’s highly impressive and speaks to the company’s business model. It’s quite another for a company that reported $182 billion in revenues in 2020 to then grow an additional 41% over the subsequent twelve months, but that’s precisely what Alphabet did.
Not only that but Alphabet reported its highest gross margin in 4 years, posting 56.9%. The story gets better. Operating income for Alphabet in 2021 was higher than the sum of what the company reported in both 2019 and 2020. Alphabet reported an astonishing $78 billion on this line item.
With so much positive news on the fundamental side, you might be wondering what gives? After all, the share price has taken a double-digit haircut over the past 12 months.
Macro Fears Weigh Heavily On GOOG
Investors have been clearly concerned that Alphabet is going to feel the brunt of recession woes. The overarching concern is that advertisers will trim their spending and hurt the company’s primary revenue generating business.
The concerns are not without merit. Alphabet grew by just 12.8% in 2020 when COVID fears were heightened and undoubtedly businesses did shave their ad budgets.
But it should be noted that the company still grew in spite of a dismal global economic climate. So, even if a recession looms, Alphabet should maintain its dominant share of Search, Digital Ads, Video (YouTube), Mobile OS (Android) and Browsing (Chrome).
But investors should still be wary, and here’s why.
Quarterly Growth Paints A Different Story
While annual growth has been stellar over the past decade, generally north of 20% – with 2021 the rare exception – quarterly growth year over year has decelerated.
- 2021 Q2: 61.6%
- 2021 Q3: 41.0%
- 2021 Q4: 32.4%
- 2022 Q1: 23.0%
- 2022 Q2: 12.6%
That’s the kind of slowdown that will spook all but the most resolute of investors. Over the same period, YouTube’s growth has declined year over year from over 80% to just 5%.
Even Google’s Cloud business has experienced a softening over the last five quarters from north of 50% to the mid-30% range.
Of course, investors should expect Cloud to grow at a much faster pace than the ad business given it’s a much smaller business unit at this time and has enormous sector tailwinds. In spite of all that growth, however, Google Cloud has still failed to turn a profit. Is management strategically choosing growth over profitability?
The bullish argument would contend that Alphabet has figured out the lifetime value of Cloud clients is so high that the returns will come later and be enormous as they are for Amazon. The bears counter that the competition with Amazon and Microsoft is so stiff now that they are forced to compete too aggressively on price.
Why The Future Is Bright
So what’s the takeaway for Alphabet? Slowing growth, a looming recession, tightening ad budgets, and a share price knocked down all suggest a company to steer clear of for now.
But remember the old adage by Buffett: better to buy a great company at a fair price than a fair company at a great price. Alphabet is currently trading at a steep discount to fair value by our calculations.
We see upside of 31.2% to an intrinsic value of $150.74 per share when forecasting cash flows. Usually our numbers are a bit more pessimistic than the market consensus but in this case we’re slightly above the Street, who have pegged fair value for Alphabet at $142.91.
Either way, the upside for Alphabet is significant and so, if you believe recessions are temporary but the fundamentals of a great company are permanent, Alphabet is a Strong Buy.