Making a value case for Google shares
Alphabet/google has been a disappointment as an investment in 2018, down almost 3 per cent for the year at $1,024 as I write. Financial markets, stung by the Facebook/Cambridge Analytica data privacy scandal, fear the impact of the EU and US Congress’ regulatory backlash on the firm that has a virtual monopoly on the global paid search business. Unlike Facebook, Alphabet has committed no outrageous breach of consumer trust but this will probably not save it from tougher data privacy scrutiny from governments anxious about losing control of the Internet and using the threat of regulatory fines to impose compliance. This has the potential to negatively impact Search, YouTube and Network.
After all, EU regulators slapped a $2.7 billion fine on Alphabet for alleged antitrust violations in online shopping — and are now reviewing Android. The Street is also fearful about a deceleration in search spend this summer. This could hurt revenue growth in Google’s websites division, the key ballast in its wildly-profitable search engine business. Advertisers face budget pressures on their spend in both paid search and YouTube. These are all reasons why I would not be surprised to see Alphabet/Google trade down to $940-$960 a share, $250 below its 52-week peak at $1,198 a share.
However, at these levels, I believe compelling value will exist to buy the shares of one of Silicon Valley’s most iconic businesses. This is one of history’s great growth companies, a global brand name franchise with a track record of stellar execution and innovation, now on sale. I recommended Google as a must-own share for investors in the UAE on the day of its IPO in 2004. Even though its shares have risen more than 10 times since its IPO, I still believe Google has a place in any sophisticated investor’s portfolio.
Google now trades at a 24 times its $42 estimated EPS. Yet this is not expensive given the sheer scale of its revenues ($110 billion) and its 16-18 per cent annual EPS growth potential in each of the next three years. The Google search engine generates 86 per cent of its parent’s revenues. This business is embedded in the world service economy and defines the online search market that is growing at 15 per cent per annum — and Google dominates it with a 65 per cent market share!
It is crucial that investors adjust Google’s price earnings ratio for $4 EPS losses in Waymo (self-driving cars and other bets) and its $100 billion cash hoard. Adjusted for executive stock options, the valuation multiple falls to 19 times forward earnings.
It is difficult to value Google’s parent, given the losses in Waymo but its addressable market (auto/transportation) is a game changer. Morgan Stanley values Alphabet on a sum of the parts basis at $1400 a share or a trillion dollars. Wall Street analyst calculate YouTube alone could be worth $150 billion, a scenario not captured in the current market cap. Waymo has an “options” value that could be north of $50 billion. Artificial intelligence, robotics, quantum computing, cloud — the most exciting trends in tech are all in Google’s future growth constellation.
The April payroll data was pure Goldilocks. Job growth was not too hot at 164,000 while wage inflation growth was muted. Yet the real catalyst for Friday’s rally on Wall Street was the news that Warren Buffet’s Berkshire Hathaway had purchased 74 million shares of Apple. However, the 3.9 per cent unemployment rate and rising core inflation means the Powell Fed will raise the Fed Funds rate at the June FOMC. This is the reason the US dollar closed at its highest levels in 2018 even though payroll growth and average hourly earnings both missed Street forecasts. The mediocre eurozone retail and service data has awakened growth fears and made it impossible for the Bundesbank’s monetary hawks on the ECB to argue for an end to Dr Mario Draghi’s bond-purchasing programme in September, given that core inflation is well below 1 per cent. This means the euro can well fall to 1.15 this summer, especially since the free-falls in the Turkish lira (a sovereign credit downgrade, political risk on President Erdogan’s snap election) and the Argentine peso (the central bank has been forced to raise rates to 40 per cent to defend the peso from a speculative assault) morphs into a full blown emerging market currency crisis.
If the emerging markets crisis escalates, the Fed will have to scale back its monetary tightening timeline. After all, tight money from the Greenspan Fed triggered the 1994 Mexican peso crisis and the 1997 Asian flu. This could create a 1999-style bubble on the Nasdaq.