Google parent Alphabet (GOOGL -0.65%) (GOOG -0.72%) -- the dog among the FAANG stocks in 2020 -- just saw its stock price surge to new all-time highs. The internet search and digital advertising leader posted a better-than-expected conclusion to 2020 and is poised to have a great 2021 as it starts to lap the initial effects of the pandemic from a year ago.
Digital advertising is still a growth industry with plenty of room to keep overtaking traditional ads in the decade ahead, but Google is actually a more diversified company these days than it gets credit for. YouTube, Google Cloud, and a diversified hardware business will be increasingly important areas to focus on in the long term.
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Using internet search profits to sow seeds of future growth
Google has been the dominant name in internet search for some two decades now, and it has regularly used its highly profitable position in this basic web staple to expand elsewhere. YouTube is a notable example. YouTube advertising totaled $6.9 billion in fourth-quarter 2020 (15% of total ad revenue), a 46% increase from a year ago. CEO Sundar Pichai said that "more than half a million channels live streamed on YouTube for the first time in 2020," underscoring how fast the online video segment is still growing.
But YouTube is a subscription business too. In fact, YouTube subscriptions (like TV and Music) were called out as the primary contributor of growth in the "Google other" segment. Google other (which also includes the Play app store and hardware, more on that in a moment) increased 27% year over year to $6.7 billion in Q4.
Google's internet ecosystem is only getting bigger as global commerce continues to migrate to a digital format. But the company is posting fast expansion outside of its core web-based properties as well. In recent quarters, Google Cloud (which is in third place in the public cloud industry, behind Amazon (AMZN -0.26%) AWS and Microsoft (MSFT -0.26%) Azure) has started getting special attention. In 2018, full-year Google Cloud revenue was $5.8 billion. In 2020, it was $13.1 billion and still growing well over 40% year over year.
The Alphabet family's top team said it will continue to invest in Google Cloud given its momentum and the massive opportunity that still lies ahead. Cloud computing is an essential business process in the wake of the pandemic and is expected to reach $1 trillion in annual global spending before the end of the 2020s. Google Cloud rang up a negative operating margin of 42% last year, but it's quickly improving and will be a meaningful contributor to Google's overall profitability in the next few years.
Google also continues its foray into the hardware world, which now includes recently acquired Fitbit alongside its Pixel mobile and Nest smart home devices. This segment's financials (also contained within the "Google other" segment with YouTube subscriptions and the Play store) didn't receive any specific callout, likely because consumer electronics had a rough year in 2020. Smartphone sales in particular took a hit early on in the pandemic, no doubt hurting the Pixel lineup of mobile phones. But a rally in this area is due in 2021, and the inclusion of Fitbit (which reported sales of $813 million through the first nine months of 2020) will also show up meaningfully on the "Google other" line item.
Google -- the diversified tech empire
Alphabet is still very much a digital advertising business, and it's this core sales generator that will often get the credit for the stock's rise. However, years of steady investment into other services are only just beginning to pay off. With the core Google search business facing a Department of Justice antitrust lawsuit accusing the company of anticompetitive activity (which likely won't go to trial for a couple more years), YouTube, Google Cloud, and a growing ecosystem of hardware and related services built on it are more important than ever. Even a successful antitrust suit against Google won't be the end of the party. Look at Microsoft. It's done more than fine after getting hit with regulatory crackdowns in the early 2000s.
Given how quickly these newer Google businesses are growing, they will be key to the stock's continued growth in the next couple of years. But this highly profitable tech empire (free cash flow generated in 2020 was $43 billion, and net cash and short-term investments were nearly $123 billion at the end of the year) is clearly dedicated to fostering expansion in new areas. I wouldn't bet against Alphabet stock further increasing in value over the next few years as a result.
