Alphabet is structured into three key business segments:
  • Google Services: This segment includes products and services like Ads, Android, Chrome, Devices, Google Maps, Google Play, Search, and YouTube. Most of its revenue comes from advertising, along with royalties from subscription-based consumer products like YouTube TV, YouTube Music, Premium, NFL Sunday Ticket, and Google One. It also generates revenue through the sale of applications, in-app purchases, and device sales.
  • Google Cloud: This segment offers infrastructure and platform services, collaboration tools, and other business solutions. Revenue for Google Cloud primarily comes from consumption-based fees and subscriptions for Google Cloud Platform services, Google Workspace tools, and other enterprise services.
  • Other Bets: This includes several smaller segments, such as Nest Labs (home automation with thermostats, smoke detectors, and Wi-Fi-synchronized security systems), Calico (biotech research focused on aging and degenerative diseases like Alzheimer's), Google X (artificial intelligence), Google Ventures and Google Capital (investment funds for startups and established tech companies), and Google Fiber (network infrastructure).
In terms of revenue distribution, Alphabet generates the majority of its income from the USA (45.8%), followed by Europe, the Middle East, and Africa (30.7%), Asia-Pacific (17.9%), and the Americas excluding the USA (5.6%).

Alphabet has demonstrated impressive growth over the years. Over the past decade, sales have increased by 18.3% annually, while earnings per share (EPS) have grown by 22% per year. In 2023, the company reported sales of $307.39 billion, with a significant portion coming from advertising revenues, primarily generated by Google and YouTube. The Google Cloud division also expanded rapidly, with revenues rising by 29% in the second quarter of 2024. We expect the company to continue growing sales by 12% annually over the next two years, with EPS increasing by 22.3% per year during the same period.

Recently, Alphabet, Google's parent company, reported strong second-quarter 2024 results, with revenues rising 14% year-on-year to $84.7 billion. Google Services revenues increased by 12%, while Google Cloud revenues grew by 29%. The operating margin improved to 32%, up from 29% the previous year, and net profit reached $23.6 billion.

Analysts predict continued growth for Alphabet. Revenues are expected to rise due to the recovery of the advertising market and the expansion of cloud services. Innovations in artificial intelligence, particularly with the Gemini model, are also anticipated to drive future growth.

Alphabet continues to innovate in artificial intelligence and cloud computing. The Gemini generative AI model has outperformed competitors in several benchmark tests, and Google Cloud achieved a significant milestone by surpassing $10 billion in quarterly revenue.
 
Alphabet boasts high margins and profitability. For the full year 2024, the EBITDA margin is estimated at 42%, the operating margin at 31.3%, the net margin at 27.4%, and the free cash flow (FCF) margin at 21.7%—representing a cash conversion rate of 79%. Return on equity (ROE) is projected to be 29.9% for 2024, up from 29.7% in 2023 and averaging 24.5% over the past five years. Return on capital employed (ROCE) and return on invested capital (ROIC) have remained around 24% and 28% respectively in recent years. Despite major investments in AI servers, capital intensity remains relatively low, with a CAPEX-to-sales ratio of 10.5% in 2023, expected to rise to 14.5% in 2024.
 
Alphabet generated substantial free cash flow of $69.5 billion in 2023. The company has a long history of strong cash flow generation, enabling it to finance its investments and innovations without relying on debt.

The company also maintains a strong balance sheet with abundant cash. As of the end of the third quarter of 2023, Alphabet had $132.6 billion in cash and investments, compared to only $13.9 billion in debt. This solid financial position allows Alphabet to keep investing in growth and innovation projects. Additionally, the number of outstanding shares has decreased from 13.75 billion in 2015 to 12.31 billion today.

With a very low debt-to-equity ratio and abundant cash reserves, Alphabet has an exceptional capacity to repay its debts. The company can also leverage its cash for strategic acquisitions or share buybacks, which could help support its share price.
 
Sundar Pichai, CEO of Alphabet and Google, joined Google in 2004 and rose to the position of CEO in 2015. Under his leadership, Alphabet has continued to innovate and grow. Pichai is widely recognized for his strategic vision and ability to lead complex teams. Ruth Porat, Chief Investment and Finance Officer, who also joined in 2015, has been instrumental in managing the company’s finances, ensuring a strong balance sheet, and optimizing investments.

At its current price of $157, Alphabet has a P/E ratio of 20.5 times estimated earnings for 2024 and 18 times for 2025. These multiples are appealing given the company's strong fundamentals. When compared to its closest peers, like Meta Platforms and Amazon, Alphabet is valued within a similar range. However, Alphabet distinguishes itself with its diversification and investments in emerging areas such as artificial intelligence and biotechnology. Historically, Alphabet has been valued at around 30 times earnings on average over the last decade, reflecting its dominant market position and growth potential. It appears the market may be factoring in slower future growth or the possibility of a break-up, which could explain the current discount. We see this valuation as attractive, especially given the growth opportunities in cloud and AI over the next decade. Additionally, a break-up could actually increase the value of each newly independent company.

Investment risks

Regulation: Alphabet is exposed to considerable regulatory risks. Authorities in various countries are scrutinizing its competition practices and data protection policies. Stricter regulations could impact its advertising revenues and data collection activities.
 
Competition: Alphabet faces strong competition from other tech giants like Meta Platforms, Amazon, and Microsoft. Its ability to retain market share hinges on ongoing innovation and its capacity to attract advertisers.
 
Dependence on advertising: Nearly 80% of Alphabet's revenue comes from advertising. An economic downturn or shifts in consumer behavior could negatively affect these revenues.

Conclusion

We are revisiting this historic stock in the Investor USA portfolio due to its enduring fundamental strengths and the current discount, which we believe is unwarranted. Alphabet remains the uncontested leader in search engines and online advertising. The company is well-diversified, with investments in emerging sectors like artificial intelligence, biotechnology, and cloud computing. Recent results demonstrate solid growth, and future prospects appear strong. With a robust balance sheet, abundant cash reserves, and low debt, Alphabet continues to innovate, notably through the Gemini generative AI model and its Google Cloud services. At the current price of $157, we see the stock as an attractive investment opportunity. Its dominant market position, diversification, ongoing growth, financial stability, and commitment to innovation make it a compelling choice for long-term investors.