Advertising dollars are increasingly moving from traditional TV ads into digital. Alphabet (GOOG 9.96%) (GOOGL 10.22%) subsidiary Google, along with Facebook, are the market leaders in the digital ad space. Google's and Facebook's market power in online advertising is so large that some call the pair a duopoly.
Google soared through the 2010s, despite facing adversities such as its legal battle with the European Commission. Its 10-year return from January 2010 to December 2019 was an astounding 405%, and Alphabet was one of the hottest tech stocks of the decade.
As Alphabet begins a new decade, it's in a strong position to continue providing excellent results to its shareholders. Here's why the company's investors will continue to earn superior returns in the next 10 years.
Image source: Google.
Advertising and other revenues are growing fast
Google is the go-to place for online search, and the No. 2 search engine is far behind it. Google's search engine has a 73% market share and is known to provide the most accurate and relevant search results. Its primary source of revenue is online advertising, which also includes advertising on YouTube, and that grew over 20% in each of the last two full fiscal years.
However, that growth has been slowing recently, with trailing-12-month (TTM) advertising revenue up just 17% compared to a year ago. Given that Google is the market leader in search, it's in an excellent position to capitalize on the shift in ad dollars moving from TV to online.
As the proliferation of low-cost mobile devices reaches the broader population in developing economies, the opportunities for Google to monetize search requests will expand. The world population is going to expand over the next decade, and most of that increase is going to come from developing countries. More people with smartphones across the globe, combined with greater availability of fast internet connections, will lead to increased revenue for the search giant.
Alphabet's other revenue, which includes Google Cloud, the Google Play Store, hardware, and other products and services, is growing rapidly. According to Alphabet CFO Ruth Porat, "Google Cloud remains one of the fastest-growing businesses in Alphabet." The worldwide cloud services market grew over 40% in 2019, and IDC expects cloud spending to increase at a compounded annual growth rate of 22% between now and 2023.
Amazon has the largest market share in the category, but Alphabet is growing its cloud revenue at an estimated two times the rate of Amazon. Admittedly, other revenue is still a relatively small portion of overall revenue at under 20%. However, the category provides excellent growth plus diversification benefits, a one-two punch that impacts valuation positively.
Excellent margins and a pristine balance sheet
Alphabet boasts a pristine balance sheet, with $121 billion in cash and cash equivalents with only $4 billion in debt. With a balance sheet this strong, the company can afford to make investments in research and development both to maintain its lead in search and develop new products and services. It can also use its cash hoard to continue buying back shares, which will provide support to its stock price.
Alphabet has been able to increase its sales and maintain excellent profit margins. Its net profit margin has held above 20% for the last three years if we exclude the one-time impact of tax changes in the U.S in 2017, while revenue also grew 20% in each of the previous two full fiscal years.
It's always a good sign to see a business can increase its sales without sacrificing its margins. This indicates that the company's products and services hold pricing power. Alphabet's proven ability to profitably grow sales is an accomplishment that's highly valued by investors.
What this means for investors
Alphabet is trading at a forward price-to-earnings (P/E) ratio of 25 and a PEG ratio of 1.5, which is a good value when considering all the positives. Moreover, its strong competitive position in fields that are growing fast, along with the balance sheet to make significant investments in research and development should enable it to grow revenue sustainably for the long run. Of course, there are risks to the stock: The main one is its heavy reliance on online advertising revenue. Any negative shock in that market could significantly impact its business.
Overall, Alphabet's ability to grow double digits in the top and bottom line, combined with its pristine balance sheet and position in an industry that's expanding quickly, make its stock a long-term buy and hold.
