Hey Google

Posted by Liz Rees in Latest insights category on 06 Feb 20

Alphabet, parent company of Google, followed in the footsteps of Microsoft, Apple and Amazon when it briefly broke through a $1trillion market valuation in January. Here we look at its development, the latest earnings report and where future growth prospects lie.

A short history

In 1998, the Google search engine was launched by PhD computer scientists Larry Page and Sergey Brin. Using advanced algorithms, it was able to deliver a far more powerful service than its competitors.

Google Inc was renamed Alphabet in 2015 to reflect the ongoing evolution from search engine to digital conglomerate. The founders stepped down as CEO and President in 2019 but remain actively involved and still control 56% of the voting rights of Alphabet.

Sundar Pichai was appointed Chief Executive of Alphabet in October 2019, having been CEO of the Google business since 2015.

Search and beyond

The core search business generates the bulk of the company’s revenues, largely derived from online advertising. Google dominates the online search market with a global share of over 80%.

Related products and services, further broaden the appeal to advertisers. YouTube and Google Maps are increasing their share of revenue and profits, along with hardware such as Chromebook laptops, Pixel smartphones and Google Nest.

Google Nest is the company’s brand offering smart devices such as the virtual assistant Google Home, a rival to Amazon’s Alexa. This allows users to give voice commands, prefixed with the words “Hey Google”. Nest’s other smart home products include speakers, streaming devices, thermostats and security systems.

Google Cloud is trying to build its position in the cloud computing market, and has appointed a top executive from Oracle to help it challenge Amazon’s AWS and Microsoft’s Azure.

Alphabet is also well placed to disrupt emerging digital markets since strong cash-flows from the core business can be used to invest in research and development, as well as promote innovations.

Such ventures include Waymo, which is developing self-driving cars. Autonomous simulation is used to test different scenarios, covering billions of miles. If it produces a safe proposition, the size of the market could be substantial.

Healthcare is an even bigger opportunity. Alphabet subsidiary Verily uses Artificial Intelligence (AI) to improve diagnostic tools, whilst Calico uses machine learning to tackle problems associated with ageing.

The company also has a semi-secret arm called X-Development. This looks to create radical technology to solve some of the world’s most complex problems. These projects are called ‘moonshots’ and Alphabet is investing billions of dollars into initiatives such as food delivery via drones, wind energy, smart cities and cybersecurity.

Latest results

Net revenues in the fourth quarter of 2019 were slightly short of expectations, rising 18% to $37.6bn. Advertising remained strong with the shortfall attributed to a slower growth in Pixel Smartphone sales and currency fluctuations. Earnings, however, surpassed expectations with a 20% increase, helped by a lower tax provision.

Pichai kept his promise to improve transparency, breaking down the contributions from YouTube and Cloud for the first time. YouTube revenues grew by 36% to $15bn whilst Cloud Computing advanced 53% to $2.6bn. However, losses from moonshot projects increased to over $2bn as investment was stepped-up in ‘deep computer science, including artificial intelligence’.

The results triggered some profit taking in the shares; this is common in companies whose shares trade on large premiums as any disappointment can unnerve investors in the short-term.

The outlook

The Google search engine, is still seen as the most advanced in the industry and ‘Google it’ has become an everyday expression. The brand has a competitive advantage thanks to its intellectual property relating to search algorithms and machine learning expertise.

The huge user base allows the company to collect valuable data, helping advertising clients achieve high returns on their outlay. Machine learning technology increases the volume and click-through rates of ads.

The company hopes to consolidate its position as market leader in online advertising whilst gaining ground in the cloud market. Cloud computing is forecast to grow rapidly in the next few years and Google Cloud has a healthy order book of customers committed to long-term relationships.

The key attraction remains the impressive cash generation and new avenues of growth. Of course not all, if any, of the moonshot ventures, will replicate the success of Google search but there is potential for significant upside and being an early mover could help establish sustainable leadership.

The risks

Like the other technology giants, faces the risk of regulatory action over monopolistic practices and data protection. Additionally, competitors have contested the methods through which Alphabet has been extending its dominance in search. However, the company is proactive about good corporate governance.

Alphabet remains heavily dependent on Google and the strength of online advertising. Even if Google maintains its leading position, a severe economic downturn could have a negative impact on revenue and cash flow.

Although the company is diversifying, some argue that it is allocating too much capital to higher-risk areas. Nevertheless, positive breakthroughs by any of the moonshots could increase the company’s valuation.

Funds that back Alphabet

If you would like to have some exposure to the fortunes of Alphabet, Morningstar silver-rated T. Rowe Price US Large Cap Growth Equity has around 6.0% of its portfolio invested in the company.

The technology experts at silver-rated Polar Capital Global Technology have approximately 7.0% of their fund in the shares whilst the more broadly based silver-rated Fidelity Global Special Situations has 3.1%, its 2nd biggest position.

Important Information: We do not give investment advice so you will need to decide if an investment is suitable for you. If you are unsure whether to invest, you should contact a financial adviser.