Key Morningstar Metrics for Alphabet
- Fair Value Estimate: $171.00
- Morningstar Rating: 4 stars
- Morningstar Economic Moat Rating: Wide
- Morningstar Uncertainty Rating: High
What We Thought of Alphabet’s Earnings
Alphabet’s network effect continued to drive growth at Google search and YouTube during the fourth quarter. In addition, as we expected, increasing demand for artificial intelligence accelerated cloud revenue growth. However, continuing weakness in Google’s advertising technology business pressured total advertising growth a bit.
We expect further declines in the network segment both this year and next, as we still think Google’s owned and operated properties remain the top priority for advertisers. We also believe more advertisers will likely use non-Google ad-tech platforms when they purchase non-Google properties. This has been a trend for more than 10 years, during which time network revenue has declined to 13% of total advertising revenue from nearly 23%.
We have increased our revenue projections for Alphabet, as the acceleration in cloud revenue growth, further monetization of YouTube, and the continuing steady growth in search will likely more than offset the impact of declining network segment revenue. In addition, we have increased our margin assumptions through 2028, given the cloud segment’s margin expansion and the success of the firm’s overall cost-control and efficiency efforts. Our model adjustments result in a $171 fair value estimate, up from $161.
Fair Value Estimate for Alphabet
With its 4-star rating, we believe Alphabet’s stock is undervalued compared with our long-term fair value estimate of $171 per share, equivalent to a 2024 enterprise value/EBITDA ratio of 15. We expect slight margin pressure in 2024, given the firm’s continued investments in growth initiatives—mainly in AI, which requires higher research and development. We look for margin improvement in 2025-28, thanks to better generative AI search monetization and faster growth in the cloud, driven by wider adoption of generative AI. Our model assumes a five-year compound annual growth rate of over 10% for total revenue and a five-year average operating margin of nearly 29%.
We expect advertising revenue to remain over 70% of Alphabet’s total revenue, driven by continuing growth in digital ad spending, albeit at a much slower rate than it’s historically seen. We model 6.5% ad revenue growth for 2024 due to slower expected economic growth than in 2023. We have estimated total Google ad revenue of $253 billion in 2024 and $272 billion in 2025. We think YouTube will contribute 13.6% of Google’s advertising revenue in 2024, up slightly from 2023, and more than 14% in 2025. YouTube growth should benefit from its impressive reach and usage frequency, plus its video-only content format, which is attractive to brand advertisers.
We believe Google will continue to gain traction in the cloud market (22% annual revenue growth through 2028). We see Google’s other revenue (non-ad YouTube revenue, Google Play Store, and sales of hardware products), up 20% in 2024 (due to strong growth in YouTube Premium, Music, and TV subscriptions) and up more than 22% in 2025.
Economic Moat Rating
We assign Alphabet a wide moat, thanks to durable competitive advantages derived from the company’s intangible assets, as well as its network effect.
We believe Alphabet holds significant intangible assets related to overall technological expertise in search algorithms and artificial intelligence (machine learning and deep learning), as well as access to and accumulation of data that is deemed valuable to advertisers. We also believe Google’s brand is a significant asset; “Google it” has become synonymous with searching, and regardless of actual technological competency, the firm’s search engine is perceived as being the most advanced in the industry. While Microsoft’s MSFT Bing is attempting to dethrone Google with AI technology from OpenAI, we think the firm can defend its dominance with its own AI technology, some of which OpenAI’s products are based on.
In our opinion, Alphabet’s network effects are derived mainly from its Google products, such as Search, Android, Maps, Gmail, YouTube, and more. Ultimately, we view Google’s network as heterogeneous. All its products have provided the company with a massive consumer base that allows it to collect data. And via its rich collection of data and large user base, Google can offer the best return on investment for advertisers and grow a network of advertising customers. The addition of each new ad and advertiser improves the efficiency of Google’s programmatic advertising offerings, allowing the firm to better monetize the network.
Google has successfully and consistently monetized many of its technology-based intangible assets in search, from the original algorithms behind the tool to the current machine learning ones and deep-learning-based generative artificial intelligence, which are also being applied to nearly every product. Google processes more than 3 times as many search requests as Bing and 4 times as many as Yahoo. Search’s success stems from the relevance of its results to its users and the likelihood that this relevance will improve as more data is gathered and analyzed, assumptions are generated, and predictions are created.
Risk and Uncertainty
Our Uncertainty Rating for Alphabet is High, primarily as a result of the company’s high dependency on continuing online advertising growth. While we remain confident that Google will maintain its dominant position in the search market, a long-lasting downturn in online ad spending could harm Alphabet’s revenue and cash flow, resulting in a lower fair value estimate. On the other hand, positive returns on Alphabet’s investments in cloud and moonshots could increase our fair value estimate considerably.
Although Alphabet’s intangible assets and network effect will help it retain its competitive advantages, the minimal switching cost of utilizing a rival search engine remains a risk for the company. But in our view, this risk is manageable, as Bing (the nearest competitor and first mover in enhancing search with generative AI capabilities) currently does not have a significant presence in the mobile market, which is one of the main growth drivers of the search ad market. Google also has generative AI technology to defend its over 90% global search market share.
The firm’s high dependence on user behavior data also represents an environmental, social, and governance risk, mainly due to risks related to data privacy and security, which could affect not only Google’s advertising business but also users’ trust in the firm’s products as data can be misused.
GOOGL Bulls Say
- As the number of online users and usage increase, so will digital ad spending, of which Alphabet will remain one of the main beneficiaries.
- Android’s dominant global market share of smartphones leaves Alphabet well-positioned to continue generating top-line growth as search traffic shifts from desktop to mobile.
- The significant cash generated from the Google search business allows Alphabet to remain focused on innovation and the long-term growth opportunities new areas present.
GOOGL Bears Say
- There is little revenue diversification within Alphabet, as it remains heavily dependent on Google and the search ad space.
- Alphabet is allocating too much capital toward high-risk bets with a low probability of generating returns.
- Google’s dominant position in online search is not maintainable, as more companies and regulatory agencies are contesting the methods through which it has been extending its leadership.
This article was compiled by Tom Lauricella.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.