Google: Buy The Split (GOOG) (GOOGL) – Search for Alpha | Hot Mobile Press

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Letters (NASDAQ: GOOD) (NASDAQ:GOOGL) sold out after a historic technology boom. But the stock may be our favorite buy among trillion-dollar companies. The advertising king holds many hidden trump cards, but also risks we dive deep. For the coming decade, we forecast returns of 11% per year.

Boom 2021

2021 has been a great year for large-cap technology companies. COVID-19 has forced many to stay home, shop online and cling to their screens. The economy hummed through 2021, as real GDP in the United States grew 5.7%, the fastest single-year increase since 1984. All of this benefited Google as people watched videos on YouTube, searched Google, and clicked on ads clicked. Consumers were awash with cash, and advertisers were awash with e-commerce sales.

As we move into 2022, the market is telling us that Google’s year-over-year growth is about to grind to a halt. In fact, Google’s earnings are expected to decline for the first time since 2017, falling from $5.61 per share to $5.44 per share as the hangover effect takes hold. But not even a brutal recession can kill the king.

The king of advertising

Google is the king of advertising and dominates search in large parts of the world:

Search engine market share

Search engine market share (serpstat)

Google’s search monopoly means it’s often the gateway for consumers finding e-commerce products. Whether you’re looking to buy an engagement ring, a t-shirt, or a car, you’re probably going to Google your options. Of course, you can shop from a brick-and-mortar retailer later, but brands have the ability to lure you in with ads on Google Search and YouTube.

Keep an eye on Amazon

Of course, competition remains a risk for Google. For example, Amazon (AMZN) is gaining market share as consumers go there to check prices on essentially anything. Once consumers land on Amazon’s website or app, Google’s search engine doesn’t matter.

Share of digital advertising revenue in the US

Share of digital advertising revenue in the US (Statist)

Google Maps is underrated

If you are looking for a service, look no further than Google Maps, which has become almost indispensable for all businesses. Android and even some Apple phone (AAPL) users always have the Google Maps app in their pocket. Are you looking for a gas station, mechanic, lawn care agency or coffee shop? Google Maps not only gives you directions but also tells you what customers are thinking with millions of reviews. Businesses on Google Maps now have an opportunity to attract more customers with Google’s paid advertising:

View Google Maps

View Google Maps (Google)

How profitable are Android and Google Play?

We don’t see how profitable Android and Google Play are individually as their profits are buried in the Google Services segment:

Google's operating income by segment

Google’s operating income by segment (annual report)

We know Google Cloud is still making losses despite its rapid growth, but how much are these other key assets making? Well, Android makes very little money by selling the operating system to companies like Samsung, instead it makes money by being the default card application, payment app, search engine and app store on every Android phone. Of these, the Google Play Store is considered the most profitable.

Android has a massive market share:

Market share by operating system shipments

Market share by operating system shipments (Statist)

In 2016, a lawyer revealed in court that Android contributed around $22 billion to Google’s net income. In 2019, Android’s cost savings and synergies contributed an estimated $19 billion to Google’s net income. Today, Android could contribute more than $30 billion to the bottom line.

Synergy of Android

Synergy of Android (Kamil Frank)

Other bets

In Alphabet’s annual report, headed “Moonshots,” management advised:

“As we said in the original letter from the founders, we will not shy away from high-risk, high-reward projects that we believe in as they are key to our long-term success.”

Sometimes we question Google’s technological prowess, but we don’t question its algorithms. For example, Google Drive is cumbersome to use, YouTube’s comments section is riddled with spam, and Apple’s iOS seems to have far fewer problems than Android. Alphabet’s bread and butter isn’t its technology, it’s its algorithms, which have led Google search to sheer dominance. We believe that Google would do best to focus on algorithms in the Other bets segment as well.

Clay Christensen, a Harvard Business School professor who famously developed the theory of “disruptive innovation,” once said at a Talks at Google event that what’s changing isn’t the job, it’s the way you get the job done. For example, we used to drive chariots, now we drive cars. We believe that if Google search is to be supplanted, increasingly clever artificial intelligence will do so. It’s much easier to ask your car, watch, phone or computer a question and get a quick answer than to search manually, especially when you’re on the road.

For other bets, Google says:

“We’re investing heavily in healthcare, life sciences and transportation.”

But the more promising deals are Google’s moonshots, “like research using artificial intelligence (AI) and quantum computing.”

We think Google agrees with us and sees the threat posed by artificial intelligence to search, which is why the company is investing in its Multitask Unified Model (MUM) software. Google says:

“We are currently experimenting with MUM’s capabilities to make searching more natural and intuitive, and even to enable entirely new search possibilities.”

Long-Term Returns

First, let’s take a look at expectations for Google’s core industries. The online advertising market is expected to grow at 14% per year through 2027. And the global cloud market is forecast to grow 16% per year through 2030, slower in developed markets. As these industries evolve into 2030 and beyond, growth will slow. Google’s Online advertising share has slightly decreased and global cloud share has increased slightly:

Global cloud market share

Global cloud market share (Synergy Research Group)

Our 2032 price target for Google is $328 per share, which translates to a nearly 11% annual return.

  • We believe Google can grow its net income at 9% per year and reach $175 billion in net income by 2032. While that’s a massive number, Google’s moat and the industry’s tailwind make it possible. Given Google’s profitability and $116 billion in working capital, the company should be able to buy back shares at a rate of 3.5% per year, with plenty of cash left over to defend its turf. That would give Google 2032 earnings per share of $18.75. We assigned a terminal multiple of 17.5x. Keep in mind that there are geopolitical, regulatory, and antitrust risks that could affect this conclusion.

Buy The Split

Despite the risks of competition, cyclicality, regulation and technological change, we rate GOOG as a Buy. The company’s competitive advantage is unquestionable and the industry tailwind is strong. While the need to search will always be there, we don’t know exactly how the “task” is being performed, but Google is tackling this with AI. Google Maps shows tremendous promise as it scales its ads. Android and the associated Google apps are hugely important and profitable assets. Google could nearly triple in a decade and return 11% per year. Our Opinion: Buy the split.

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