Shortly after Sundar Pichai became CEO of Alphabet (GOOG 0.74%) (GOOGL 0.55%) in 2015, he boldly proclaimed that his vision was to evolve into an AI-first company. Alphabet's consistent investments to support long-term growth are certainly reflected in its strong financial performance. Although the company competes with other technology behemoths such as Amazon (AMZN -1.64%), Microsoft (MSFT 0.37%), and Netflix (NFLX -3.92%), Alphabet's most recent quarterly results lead me to believe that it could very well become the biggest company in the world in terms of market cap in the not-too-distant future, replacing Apple (AAPL 1.27%).
Alphabet stock is up over 67% year-to-date, nearly triple the 24% gain of the S&P 500. Let's dig into the financials to see if these market-beating returns can continue.
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An astounding pace of growth from YouTube
Alphabet generated $65 billion in revenue in Q3 2021, representing 41% year-over-year growth. Although this level of growth for a company of this magnitude is stunning, I was more intrigued as to which business segments contributed the most to the company's performance.
The breakdown of Alphabet's quarterly revenue is as follows: Advertising ($53.1 billion), Other ($6.9 billion), and Google Cloud ($4.9 billion). Per the company's latest Q3 filing, investors can see that YouTube generated $7.2 billion of advertising revenue in the quarter. On a year-to-date basis, YouTube has generated $20.2 billion in revenue, compared to $12.9 billion for the first nine months of 2020. This represents 57% year-over-year growth.
To put this into context, Netflix posted $7.5 billion in revenue in Q3 2021 and $21.9 billion year-to-date. Comparing this to $18.4 billion for the first nine months of 2020, Netflix is growing revenue 19% year over year. YouTube is now operating on an annualized run-rate of $30 billion in revenue and growing at nearly triple the rate of Netflix. Considering Alphabet acquired YouTube for $1.65 billion in 2006, it has seen an incredible return on investment over the last fifteen years.
Capitalizing on cloud growth
Alphabet's Google Cloud business generated $4.9 billion in revenue in Q3 2021. On the other hand, Amazon's cloud product, AWS, generated $16 billion of revenue in Q3 2021. It's important to note that Google Cloud is nearly one-third the size as AWS. However, a slew of companies, including Amazon, Microsoft, and Alphabet are well-positioned to benefit from increased cloud adoption. In fact, Gartner (NYSE: IT) predicts that worldwide spending on public cloud services will increase from $243 billion in 2019 to $692 billion by 2025, representing a 16% compound annual growth rate (CAGR). Moreover, large software companies such as Snowflake (NYSE: SNOW) typically rely on more than one public cloud, providing ample opportunity for Alphabet to gain market share, even if other players are involved.
Alphabet & AI
Artificial intelligence has been a core theme for big tech. Microsoft has a venture fund focused on AI and uses the technology to build apps in Azure and support interaction with Cortana. Amazon leverages AI in the form of its recommendation engine, the robots that power its warehouses, and for its voice assistant, Alexa. On the other hand, Apple and Netflix have lagged behind other FAANG members when it comes to AI. Notably, Netflix really only has one product offering (streaming), which does not provide it with a great opportunity to invest in new technologies and differentiate itself among its peers.
Although competitors like Microsoft and Amazon are now investing aggressively in AI, investors could argue that Alphabet had a head-start, and now other big tech actors are playing catch-up. Alphabet's original product offering, Google search, leveraged AI in its algorithms. Moreover, the suggested reply functionality in Gmail uses AI. Similar to Alexa, Google Assistant depends on natural language processing to interpret voice commands. Alphabet also has its own version of Apple's App Store, Google Play, and consumers can shop easily online for food or other products. Alphabet's strategic investments have allowed it to effectively build and offer consumers similar experiences that other tech giants offer, but all in one ecosystem. I think that we are seeing the return on these investments in the form of high double digit revenue growth and increased profit margins, putting Alphabet well ahead of its FAANG peers.
Now what?
Amazon, Microsoft, Netflix, and Alphabet are all well-capitalized businesses. These four companies are investing heavily into multiple business segments and compete in overlapping industries. However, Alphabet's growth rate sticks out among these members of the FAANG club. Microsoft's Q3 revenue increased 22% year over year while Amazon's increased 15%. Alphabet's revenue increased 41% year over year, nearly double that of Microsoft and almost triple that of Amazon.
Alphabet's investments to become an AI-driven company are paying off in meaningful ways, and as the world becomes a more digitally connected place, several of Alphabet's product lines and business segments are poised to benefit. For this reason, I think that when it comes to FAANG options, Alphabet is emerging as the clear leader and as such, deserves a chance in your portfolio.
