Hello Dede. Thank you for the update and transparency. I fully understand your reasoning but wanted to ask you why you did not trim instead of complete exit. You know that markets are not completely rational. Also in my opinion Alphabet is the only AI company that has own hardware (AI chips), platform and AI models. Personally I was thinking about trimming if/when stock price reaches 350 USD. But would not exit complete position in one of the best companies in the world. When would I have another chance to buy it cheap?
Hi Jovan, thanks for the question. To be honest, there's no perfect answer, and I think we'd all have our different answers and estimates. I usually trim stocks when the potential IRR for my investment case goes below 6%. However, Alphabet went below 3% IRR earlier today, which is why I decided to exit fully. I certainly agree with you on the vertical integration regarding Alphabet; that point formed the basis of my initial investment case https://globaloutperformers.substack.com/p/alphabet?utm_medium=web. I'm more anchored towards potential IRR over 3-5 years than stock prices or market caps. To justify its current 30x forward earnings, I think Alphabet would need to accelerate from a 12-13% grower to 17-19%. For context, 5% additional growth is $17 billion in revenue or $5 billion in net profits - that's equivalent to all the revenue Alphabet made from its cloud division in 2021 or YouTube in 2020. It's possible, but many things would need to go right here, and I doubt the likes of Apple/Microsoft/Amazon would be asleep.
Dede, a great article. Timely for me as well, as after a ~100% gain on Alphabet I'm going through the same thought process, so thanks for publishing! Firstly, I just wanted to make a couple of points around the article.
I think people underestimate some of the drivers still remaining in Google Search. AI use for targeting via Performance Max is driving huge conversion gains for clients (in some cases >20%). The conversion uplift will naturally come down, but any increases in conversion (i.e., higher value adds) on Google's existing revenue base will still be massive growth. Secondly, they have already commented AI ads monetize at the same rate as existing ads. If that holds true, given AI is leading to more frequent search and Google has expanded its search surface via AI mode, I think you could see a very low deceleration on core search for a number of years. Of course, consumer transition to LLMs is the big risk here.
The subscription growth also includes growth from Google One (Gemini paid subscriptions) which is an entirely incremental revenue source for Alphabet. Given Youtube still hasn't reached its full potential (Youtube TV, AI ad-placement), I think there is a very (This sentence seems incomplete/trailing off. I've left it as is but noted the potential issue.)
On Network, this is Google's lowest margin, lowest value area. Google wants this division to disappear as it would be both a growth and margin benefit to them.
Google Cloud's growth is currently supply constrained and has been for a number of quarters. I believe a large degree (potentially the majority) of the current capex is going into expanding capacity. With 70% of AI startups using GCP and their demand being off the charts, it's very unlikely we see a slowdown anytime soon. I would expect the division to exhibit non-linear growth, much in the same way other hyperscalers have. This growth profile also supports margin expansion in the long term as the economics on compute in GCP are more attractive.
This is all a very long-winded way of saying that I think your fade rate on the business is likely too aggressive. My own rough estimates I can get to roughly 12% CAGR through to the end of the decade and slightly higher margins due to op leverage.
How did you quantify the possibility of upside surprise to earnings? A slightly higher growth profile would have put your IRR into the "reduce" bucket. This is where I currently am, toying between an exit and reducing the position. But more broadly, given the extent of the structural opportunities for Alphabet, I'm worried that we could ultimately be underestimating the earnings potential.
Hello Dede. Thank you for the update and transparency. I fully understand your reasoning but wanted to ask you why you did not trim instead of complete exit. You know that markets are not completely rational. Also in my opinion Alphabet is the only AI company that has own hardware (AI chips), platform and AI models. Personally I was thinking about trimming if/when stock price reaches 350 USD. But would not exit complete position in one of the best companies in the world. When would I have another chance to buy it cheap?
All the best.
Hi Jovan, thanks for the question. To be honest, there's no perfect answer, and I think we'd all have our different answers and estimates. I usually trim stocks when the potential IRR for my investment case goes below 6%. However, Alphabet went below 3% IRR earlier today, which is why I decided to exit fully. I certainly agree with you on the vertical integration regarding Alphabet; that point formed the basis of my initial investment case https://globaloutperformers.substack.com/p/alphabet?utm_medium=web. I'm more anchored towards potential IRR over 3-5 years than stock prices or market caps. To justify its current 30x forward earnings, I think Alphabet would need to accelerate from a 12-13% grower to 17-19%. For context, 5% additional growth is $17 billion in revenue or $5 billion in net profits - that's equivalent to all the revenue Alphabet made from its cloud division in 2021 or YouTube in 2020. It's possible, but many things would need to go right here, and I doubt the likes of Apple/Microsoft/Amazon would be asleep.
Should merit as a good call since strictly in line with investment philosophy !
Besides 2029 is a long way to go !
Dede, a great article. Timely for me as well, as after a ~100% gain on Alphabet I'm going through the same thought process, so thanks for publishing! Firstly, I just wanted to make a couple of points around the article.
I think people underestimate some of the drivers still remaining in Google Search. AI use for targeting via Performance Max is driving huge conversion gains for clients (in some cases >20%). The conversion uplift will naturally come down, but any increases in conversion (i.e., higher value adds) on Google's existing revenue base will still be massive growth. Secondly, they have already commented AI ads monetize at the same rate as existing ads. If that holds true, given AI is leading to more frequent search and Google has expanded its search surface via AI mode, I think you could see a very low deceleration on core search for a number of years. Of course, consumer transition to LLMs is the big risk here.
The subscription growth also includes growth from Google One (Gemini paid subscriptions) which is an entirely incremental revenue source for Alphabet. Given Youtube still hasn't reached its full potential (Youtube TV, AI ad-placement), I think there is a very (This sentence seems incomplete/trailing off. I've left it as is but noted the potential issue.)
On Network, this is Google's lowest margin, lowest value area. Google wants this division to disappear as it would be both a growth and margin benefit to them.
Google Cloud's growth is currently supply constrained and has been for a number of quarters. I believe a large degree (potentially the majority) of the current capex is going into expanding capacity. With 70% of AI startups using GCP and their demand being off the charts, it's very unlikely we see a slowdown anytime soon. I would expect the division to exhibit non-linear growth, much in the same way other hyperscalers have. This growth profile also supports margin expansion in the long term as the economics on compute in GCP are more attractive.
This is all a very long-winded way of saying that I think your fade rate on the business is likely too aggressive. My own rough estimates I can get to roughly 12% CAGR through to the end of the decade and slightly higher margins due to op leverage.
How did you quantify the possibility of upside surprise to earnings? A slightly higher growth profile would have put your IRR into the "reduce" bucket. This is where I currently am, toying between an exit and reducing the position. But more broadly, given the extent of the structural opportunities for Alphabet, I'm worried that we could ultimately be underestimating the earnings potential.