Google Stock: Fundamentals Continue to Improve (NASDAQ:GOOG)

introduction

I had a “strong buy” thesis about Google (NASDAQ:GOG) in early March. I can credit myself with that call, as the stock is up 30% since my recommendation, compared to a modest 2.6% gain for the S&P 500. The company continues to demonstrate strong growth momentum in digital advertising and the cloud. These industries are expected to show strong growth over the long term, which means my bullish stance is intact. Google is reinvesting its large profits in new projects, and has great potential to dominate the self-driving industry, which could grow into a $400 billion monster, according to Google. Mackenzie. The valuation is still very attractive, and I tend to repeat the phrase “Strong Buy” for GOOGL.

Fundamental analysis

Google generated revenue of $80.54 billion in the first quarter of 2024, representing a solid 15.4% year-over-year increase. Revenues grew faster than expenses, which meant improved profitability Significantly. Operating margin improved from 25% to 32% year over year, allowing diluted EPS to increase by 62%.

The revenue increase in the first quarter was of high quality because all segments showed strong growth, meaning the company was not relying on a single growth driver. This diverse performance indicates broad business health and resilience to external fluctuations, proving my bullish thesis. I want to emphasize that Google Cloud’s revenue grew 28.4% year over year, which beats the industry by more than seven percentage points.

Strong growth was demonstrated not only across all business segments, but also across all geographies. This indicates the strength of Google’s business model, which works successfully across jurisdictions, cultures and markets. Another strong point that supports my bullish stance.

To summarize the first quarter results, Google achieved excellent, high-quality revenue growth. Financial discipline allowed the company to significantly improve profitability.

Digital advertising is Google’s largest source of revenue, and the company’s cash cow ensures exceptional profitability. Therefore, it is important to understand the future prospects of this industry. According to the source, digital advertising is doing well and the overall spending growth forecast for 2024 was recently upgraded from 8.4% to 9.2%. Google Ads revenue rose 13% in the first quarter, significantly exceeding expectations for the entire industry. According to Grand View Research, the global digital advertising market is expected to show a CAGR of 15.5% by 2030. This means that the industry trends for Google’s main revenue stream are very positive.

Google’s second-largest source of revenue is Google Cloud, accounting for nearly 12% of total first-quarter revenue. The industry is so hot that two other cloud giants, Amazon (AMZN) and Microsoft (MSFT), have been boosting their cloud and data center spending amid the AI ​​battle. Google also has ambitious plans and is willing to spend aggressively on artificial intelligence. My confidence is backed by the power of Google Cloud.

Bears might say that Google Cloud is miles behind AWS and Azure in terms of market share, and that’s true. However, as I mentioned earlier, it is growing faster than the industry and its market share has nearly doubled between 2017 and 2023. This significant expansion in market share is strong evidence that management is doing the right thing in this direction. Moreover, Google’s historical ROIC is much higher compared to Amazon, and the gap with Microsoft is rapidly closing.

So, I believe Google is one of the major beneficiaries of the accelerating cloud and AI transformation. According to Precedence Research, the cloud infrastructure market size is expected to expand at a CAGR of 12.1% from 2023 to 2032. This represents another supportive force for Google and a strong reason to remain bullish on Google.

The company also continues to invest in new projects outside of digital advertising and the cloud. A self-driving taxi technology called Waymo seems to be the most promising, in my opinion. The service is already available in some parts of large cities such as Los Angeles, San Francisco and Phoenix. Later this year, the company also plans to launch its services in Austin. McKinsey expects self-driving to generate $300 billion to $400 billion in revenue by 2035. As an industry leader and Google’s massive financial and human capital, the company is poised to capture a significant portion of the industry in the future. Capturing at least 15% of a $400 billion market would mean $60 billion in additional annual revenue. Given Google’s TTM price-to-earnings ratio of about 7, $60 billion in additional revenue means an additional $420 billion to market cap. The level of uncertainty is very high, so I do not take it into account in my assessment below. However, I just want to emphasize the huge potential of this work in the long term.

Evaluation analysis

After significant increases occur over relatively short time frames, there is a possibility that the stock price will exceed its fair value. To check this, I run a discounted cash flow (‘DCF’) model with an average cost of capital of 8.3%.

2024-2026 revenues are the consensus of more than 20 Wall Street analysts, which appears to be a representative and reliable sample. For 2027-2028, it included a slight deceleration in revenue, with comparable numbers expanding. Given Google’s fundamental strength and continued growth reinvestments, I believe a steady growth rate of 5% is fair for calculating terminal value (“TV”).

Google’s TTM FCF margin is 17.31%, and this would be my default for fiscal year 2024. For 2025-2028, I expect an annual expansion of 100 basis points. I’m optimistic about FCF’s expansion potential because the consensus forecast for EPS is quite optimistic. According to Seeking Alpha, there are 12.36 billion GOOGL shares outstanding.

The upside potential is 11%, according to my calculations. Google’s fair share price is around $194, which means the current price of $175 per share is attractive.

Analyzing Google’s peer rating seems like an impossible task because the company’s positions in digital advertising and search engines are unparalleled, which means there are no peers. However, looking at the future expectations of the P/E ratio is very useful.

According to the screenshot above, GOOGL’s P/E ratio is expected to shrink to approximately 15 over the next few years. This seems like an unrealistically low price-to-earnings ratio for a company like Google. Therefore, I think the P/E ratio also shows the depreciation of the stock.

Mitigating factors

The pressures exerted by antitrust authorities appear to be increasing. In late March, there was information that American tech giants, including Google, were facing new investigations under new EU digital laws, which could result in significant fines. According to yesterday’s news, the US Congress has requested an investigation into technology companies that hide antitrust evidence. All of these investigations and investigations may result in significant fines and penalties. Furthermore, Google faces reputational risks if the company’s misconduct is proven.

Google continues to dominate the global digital advertising market. However, competition is heating up, especially from Amazon. According to Statista forecasts, Google’s share of the digital advertising market is expected to shrink by about 250 basis points. Meanwhile, Amazon’s market share is expected to expand from 12.9% to 15.2%. According to the chart above, Google is expected to remain the undisputed number one player in the industry, but investors should be aware of stiff competition from AMZN.

Conclusion

Google is strong across all revenue streams and geographies. Relying on a wide range of revenue growth drivers means there is great potential to maintain a strong trajectory over the next several years. There is great potential for Waymo to dominate an industry worth hundreds of billions of dollars in the long term. The valuation is still very attractive, which means the “Strong Buy” rating from GOOGL is well deserved.