Description

Over the last 15+ years, Alphabet (NASDAQ: GOOGL) has been written up on VIC nine times as a long and once as a short. I believe the main reason why it’s been written up so many times as a long during this time is that its average forward P/E multiple over this 15+ year period is just 21.7x. In fact, if you back out its consistent net cash balance sheet position and adjust the S&P 500’s average forward P/E to an unlevered basis, GOOGL has barely traded at a premium valuation despite organically growing its revenue and earnings at a much faster rate. Today it trades at a discounted valuation of just ~17x 2025E EPS (excluding its net cash position and losses from Other Bets).

If you take a step back and really think about it, GOOGL has essentially been mis-priced for most of its publicly traded 20-year history, which is hard to believe. It seems like the market has always had its reasons for assigning a relatively low multiple to GOOGL despite its significantly above average growth rate. Over the years there was skepticism over how search would monetize with the transition from user’s time increasingly moving from desktop to mobile. Would be competitors from MSFT to AAPL might crush them. AMZN’s Alexa and AAPL’s Siri would result in more voice-based search and thus users would use their screens less thereby hurting its ability to monetize search through ads. Because the traditional advertising industry is economically sensitive, the market has often viewed its business deserving of a lower multiple due to the more cyclical nature of the industry. However, its results over time have shown that it’s much more of a secular grower and less cyclical.

Last, but not least has been an ever-present myopic view that because the traditional advertising market is only so large, therefore online advertising can only be so large as it must be defined within that context. What the market misunderstood was that as business models (i.e. how goods and services were delivered to customers) changed thanks to the internet/mobile devices, companies’ cost structures and investments changed as a result. For example, a traditional “retailer” of clothing that historically needed a store presence (which partly served as marketing) to get its good/services to a customer is no longer necessary and therefore more of that expense is freed up to be spent on customer acquisition cost (CAC) through online advertising channels such as search and social media.

Today the market has a new fresh set of worries for GOOGL’s search business. Some of the key bear arguments I’ve heard are:

• AI based search alternatives from competitors such as OpenAI and Perplexity are going to kill its business

• With 90%+ market share, it can only go down from here

• Government actions will prevent it from paying AAPL its traffic acquisition cost (TAC) to be the default search engine on Safari and thus it will lose significant, profitable share

Basically, GOOGL has been presumed guilty until it can prove its “innocence” that its search business won’t be disrupted by AI or government actions and therefore can continue to grow.

Here are my rebuttals to some of the bear arguments:

• GOOGL’s own AI, Gemini, has made great strides over the past couple years. The gap in quality between it and OpenAI for search has narrowed considerably. Even co-founder, Sergey Brin, is back at GOOGL full time working on this practically seven days a week.

• I believe AI (voice to voice) will be complimentary in nature to how we conduct our searches. For certain queries where there is a definitive answer (example: what was the score of today’s Yankees game?), AI will be better. However, many queries are much more nuanced with respect to the individual asking the question where there is no definitive answer per se. I believe in many cases traditional search or AI search (voice to text/images/links) will continue to be the most effective for many years to come.

• Even if AI (be its own or competing platforms with voice to voice) takes away meaningful share from traditional search as it relates to definitive answer queries, the remaining ads on traditional search queries or AI (voice to text/images/links) may monetize at a much better relative rate and therefore it may not lose much share of the most profitable parts of search. Thus the number of ads served could be less, but the price per ad could increase to a rate that more than makes up for less impressions.

• It can lose market share, but still have a very good, growing search business. Look at AWS for example. It’s been losing share to MSFT’s Azure and Google Cloud for years but continues to grow at a double-digit clip because the market continues to grow at above average rates. Search organizes the world’s information. If information continues to grow faster than population growth, so should search.

• Assuming GOOGL is no longer allowed to pay AAPL TAC to be the default search engine for Safari, if Safari’s quality of search were to suffer, many users would likely use GOOGL’s Chrome app instead. Additionally, it is estimated that GOOGL pays AAPL ~$20B annually in TAC. With that large expense freed up, GOOGL could be more aggressive in marketing/selling its Pixel phone (which has Chrome/Google search as the default) with increased promotions/subsidies through wireless providers to make the Pixel that much cheaper vis-à-vis competing phones. Over time this could help recapture some of the lost market share.

• The dominant communication form factor may switch to glasses over time. META believes this could happen and is investing significantly behind it. So, who knows if AAPL’s toll road via Safari will be worth as much (or cost as much) in the future.

Implied Valuation of Google Search

I bring this up because it helps one see just how negative the market is on Google search. If you back out the net cash on its balance sheet and losses from Other Bets as well as the implied values of YouTube (NFLX as a comp), Google Cloud (MSFT/AMZN as comps) and Google Play Store/Android (AAPL as a comp), the market is valuing Google Search at ~10x 2025E after-tax earnings. The closest comp to Google Search for a pure-play online advertising business is META’s social media business. The implied valuation of META’s core Family of Apps business (backing out the losses from Reality Labs and its net cash) is nearly twice the implied valuation of GOOGL’s search business.

META’s social media business deserves to trade at a premium relative to Google’s search business given its current faster growth rate and potentially more durable business. But less than two years ago the market took the opposite view because of AAPL’s maneuvers that made it more difficult for META to track users’ online activity and therefore properly target advertise to them and track the ROI on ad spend. META ultimately solved that problem, which many didn’t think was possible. It wouldn’t be surprising to see sentiment change just as easily for GOOGL as it did for META if Google’s core search business continues to grow at a high-single digit or better rate over the next few years.

Optionality

This is what makes me that much more bullish on GOOGL as a long-term investor. If you look at many of the most valuable companies today so much of it comes down to which ones had the most optionality over time. For a company to create optionality, it must have an entrepreneurial culture that invests significantly behind innovation. Here are some examples:

• AAPL’s iPod (with iTunes) leads to the iPhone which leads to the iPad, services, wearables, Apple TV, Apple Music, etc. Today the iPod is no longer made.

• AMZN selling books itself leads to it selling a ton of other categories in 1P, then through 3P, logistics, Prime (including Prime video), AWS, kindle, advertising, Amazon music, Alexa, grocery/Whole Foods, self-delivery, etc.

• NFLX began as a pure online DVD rental business, which led to streaming other companies’ content, which led to producing its own content for its streaming service. One of the things that differentiated its streaming service is that its content never had ads and now it has a less expensive ad option with a fast-growing advertising business. It’s no longer in the DVD rental business.

Waymo + AI/Gemini + Other Bets = A Ton of Optionality

GOOGL owns nearly 100% of Waymo. If you have yet to try Waymo, I highly recommend you do. About a year ago I was driving home at night in heavy traffic on a busy street and I saw for the first time a driverless Waymo car whereas before there were always test drivers in them.

I marveled at how well the car handled the conditions with terrible drivers cutting it off, huge potholes to avoid, illegally parked cars in certain lanes, rain, etc. I immediately downloaded the app and got onto the waitlist. I’ve been using the service regularly for several months. It is a game changer—not just for transportation as we know it, but potentially for so many other industries. The use cases are numerous—much more than just a better version of Uber/Lyft/DoorDash. Don’t ask me to try to quantify today what the opportunity amounts to because it’s unknowable. But in the same way when I bought AAPL stock in April 2003 as the iPod (with iTunes) was a new business for it (with a far superior product and service relative to MP3 players/burning CDs from Napster/Kazaa downloads), I feel similarly about Waymo.

It is a much better product/service—you get a consistent fleet of brand-new, clean Jaguar EVs where you can choose the music (or none) and climate of the car with a ride that is priced at or less than Uber X. Having no drivers is not only a nicer, consistent experience, but it also provides peace of mind for parents to have their children use it unaccompanied. Same goes for women. And not only is it a much better offering, but its marginal cost can approach near zero over time. Talk about a blockbuster combination: much safer, better quality priced less (and potentially much less) than the human-based version. No wonder Uber is so willing to partner with Waymo.

If you have some imagination, think about the possibilities. If Waymo’s technology allows it to navigate difficult driving conditions more successfully (defined by safety—rate and severity of accidents) than human drivers, what else might this technology be used for? Could it replace humans driving forklifts inside warehouses? Could it replace bus drivers and truck drivers? Could it reduce the number of pilots needed to fly a commercial airplane or conductors for a train or subway? Could it entirely change the way we transport ourselves and goods daily? At night our highways could be filled with driverless trucks and cars transporting goods so that during the day there would be less traffic from those vehicles. Will we need less trucks, busses and cars and therefore less parking spaces (which improves traffic from more lanes) as the utilization of these assets can increase dramatically over time? There are many ways this technology could be monetized over time—be it in-house at GOOGL or Waymo or licensed to other companies that want to focus on a particular niche.

As of today, there are only two companies working on driverless technology and AI—GOOGL and TSLA. With TSLA you are paying a big premium for its future potential with these new technologies whereas with GOOGL (assuming its search business is not disrupted by AI/government actions), you’re essentially getting them for free.

An Investment in GOOGL is an Investment Behind Large Societal Productivity Improvements

So much of global economic growth is tied to productivity enhancements—the ability of our economy to do more with less thanks to new technologies. 

When you look at GOOGL’s businesses (Search, YouTube, Google Cloud, Google Play Store, Android, Pixel, Google Workspace, etc.) the one thing they all have in common is they increase society’s productivity meaningfully. And that’s exactly how Waymo and AI/Gemini fit in. Society will adjust to the increasing adoption of these new technologies just as it always has. Some jobs will be eliminated, new ones will emerge, and others will evolve with it just as mine has. Overall, global economic growth will be positively impacted.

Bottom line, an investment in GOOGL is an investment in a company that can help society become more productive and efficient. That is good because it can improve the quality of life by helping make goods and services more affordable for more people across the world and improve how our time is spent.

Lastly, I love that one of the co-founders, Sergey Brin, is as engaged as ever. 

https://www.youtube.com/watch?app=desktop&v=XzK9bx3CSPE

I generally have had good outcomes investing in companies that continue to be founder led. While that isn’t exactly the case here, it’s close.

The market is giving us an opportunity to buy a high-quality compounder (organically growing revenue and EPS at a well-above average rate) at a below market valuation with a ton of optionality. Hopefully, some of that optionality will bear fruit over time.

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Catalyst

Google's Search business continues to grow at an above average rate as AI is complimentary rather than disruptive to its search business. Government actions do not materially hurt its businesses. Waymo blossoms into a hugely profitable business over time. Its own AI (Gemini) is value enhancing to its existing businesses and potentially results in new business. Some Other Bets hit.