MI Rewind: Alphabet Stock Deep Dive w/ Rihard Jarc

0:00You're listening to TIP. Hey guys, on today's show, I'm resharing a favorite episode from the past. I like to do this because we get a lot of new listeners each week, and they will never have heard this excellent episode before. And even if you've been listening for a while, you may have missed it when it first came out, or you could at least benefit from reviewing some of this episode's lessons again and reinforcing your learning. If you're not interested in episodes from the past, there's no hard feelings at all, and you can pick up with us again next week for a brand new episode. Everything going forward is from the original, and I hope you guys enjoy listening to it as much as I did.

0:38Yes. As you mentioned, Erderbets is a well-known, let's say, segment of their business, because that is where the famous moonshot factory called X is, right? These are these crazy ideas that Google employees have and that they mature and develop a startup incubator, if you will. And what came out of this X factory, the most important part right now, I would say, is Vamo.

1:05On today's episode, I'm joined by Richard Jark. Richard is the chief investment officer of New Era Funds and runs an investment newsletter called Uncover Alpha. During our conversation, Richard and I do a deep dive on Alphabet stock, better known as Google. We chat about Alphabet's main sources of revenue, why Google search is such a valuable resource for advertisers to acquire new customers, what is included in Alphabet's Other Bets line of business, where Alphabet sits in the AI industry, potential risks for the company, why Richard is bullish on Airbnb, and much more. Alphabet or Google is a company I've been keeping my eye on and I believe is an investment worth looking into due to their strong growth and tailwinds for the company, as well as their very strong competitive moat.

1:53Airbnb is another company I'm really interested it in. So I'm glad I got the opportunity to chat about it a little bit with Richard at the end of the episode. So be sure to stick around till the end. With that, I hope you enjoy this deep dive into Alphabet with Richard Jark as much as I did. You're listening to Millennial Investing by the Investors Podcast Network, where your hosts, Robert Leonard and Clay Fink, interview successful entrepreneurs, business leaders, and investors to help educate and inspire the millennial generation.

2:28Welcome to the Millennial Investing Podcast. I'm your host, Clay Fink. And on today's episode, I'm joined by Richard Jark. Richard, pleasure having you on the show. Thanks for inviting me, Clay. Now there's this website I've started using fairly frequently called DataROM. And it shows the portfolio holdings and portfolio changes of what they call super investors. And on that site, there's a list of all of the best investors on the planet, and it shows each of their top 10 holdings. And when I search for Google stock on that page, I see that about half of the super investors own that stock. So I thought it'd be a really good opportunity to bring you onto the show to chat about Google and why it is such a great company, which I'm sure most people or many listeners that are tuning in are probably aware of.

3:14Let's start with a high-level overview of Google. They're most well-known for their search business, but they've expanded into a number of other lines of business as well. So Richard, could you please outline what their primary sources of revenue look like currently? Sure. So as you mentioned, search is their main revenue factor, but then they also have Google Network, which is also advertising, but it's advertising from properties that aren't theirs. So the most common example of this is the AdSense platform. Then they also have YouTube ads. So YouTube is a big part of their business. I would say in the last 10 years, it has probably grown the most from their properties.

3:56And then you have Google Cloud, which is again, really important, especially looking at the company down the line. And then you have other revenue, which basically is revenue from fees from Google Play Store, hardware revenue like Fitbit, Nest, Pixel phone, and also really important, YouTube's non-advertising revenue. YouTube Premium, which is a subscription service, you pay to not get ads. The revenue from that segment is in Google Other Revenue. And then when it comes to the last segment, I would say it's Other Bets, but in terms of revenue, it's not really that important yet. Robert Leonard Google stock has been a top performer since the COVID pandemic hit.

4:40Their total revenue grew from a whopping$182 billion in 2020 to$257 billion in 2021, a 41 % increase over a year, which is pretty remarkable for how big of a company they already are. What were some of the biggest drivers in this massive growth, especially higher growth compared to a lot of the other big companies that are out there? So what were the biggest drivers of this growth? And do you expect them to be able to sustain these revenues? Or is it sort of a temporary COVID push? I'm curious what your thoughts are around that. In the last two years, definitely the biggest push in terms of accelerating the business was definitely the pandemic.

5:20And it influenced Google in two ways. First of all, the users, they got more engaged online because we were in lockdowns. Nobody was really doing anything, So you got more engaged online and Google with YouTube is one of the main focuses of what you're doing. And then also in terms of from the business side, if businesses wanted to reach their clients, the only way to do it was online. So the advertising went even more to online. And another, I would say, big tailwind for Google, at least for last year, was also the iOS change. So the Apple privacy change, which basically it's much harder for companies like Facebook or Snapchat or these other companies to efficiently target the users.

6:05And because of this, Google kind of got even more advertisers to join their platform. And then also, if we look at the cloud business, for example, right, the cloud adoption has been a tailwind for many years now. And again, it kind of received an additional bump, if you will, in the last two years, because also companies are now transitioning even more from on-premise architecture and software to the cloud. And this is, again, a big beneficiary of all this is Google. When you ask if it's sustainable, at least in terms of this revenue growth, I would say when it comes to advertising, we already see the slowdown happening in the first half of this year, mostly because of macroeconomic conditions, the war, stuff like that.

6:48But at the same time, it's also tougher. we have tougher comps because you said they grew over 40%. I think the advertising revenue will come back to some normalized levels. While the cloud business, I still think will be a big tailwind and a big driver of growth. So we could see in the last report, it's growing over 40 % still, and there are no really signs of this adoption slowing down. Since a lot of Google's revenue is from their search business, I think it's important to understand the business model there. What is it that makes Google search engine so valuable to advertisers? Why would a business want to advertise on Google rather than other platforms such as Facebook or another option?

7:34I mean, when it comes to advertising, it always comes down to return on advertising spend, right? This is the thing that all advertisers look at. So how much am I getting from my ads dollars? But I think to show an example, I think it's really useful. You have to look at also the use cases of why you would use Google. For example, I used to run a software company. We were focused on developers. So we were an API company selling a SaaS service. And our target clients were developers. And because we were selling a niche service for document data extraction. And if we wanted to reach this client, we couldn't use Facebook or any other of these services, because it's a really niche environment and a niche kind of thing that we targeted, right?

8:17And it was much more effective to just target the search, right? So if somebody is looking for document data extraction, then you can pop up and the efficiency of this advertisement is much better. I think it's important to understand that if you're a big company, Google is probably your primary source of advertising, because it's much more effective to target. On the other hand, if you're selling a B2C product, So to end clients, something like a Facebook or other platforms are effective as well, because it's easier to reach the users. But again, I also think Google is maybe more targeted toward intent than other platforms.

8:53Because for example, if you're on Instagram or Facebook, the main goal of the ad is to persuade you to buy something that you really didn't thought of buying. While on Google, especially on search, you are looking for something specific. And if it's an advertising, but it's actually what you were looking for, it's very helpful for you. as well as for the advertiser, right? This is a question that just came to mind as you were answering that question relates to the advertising. Is the CPMs anything you look at? I know when Google first started, I'm sure the CPMs were dirt cheap. You could buy ads for pennies on the dollar.

9:27Are we seeing the CPMs still go up over time as more and more people are using Google all over the world and that advertising real estate is becoming more valuable in the advertiser's eyes. So I'm curious what your thoughts are around the CPM numbers. CPM, of course, is really important. And yes, they are going up. So the more you narrow down the search, the more costly they become. Because everybody's targeting, at least in terms of your competitors, if you're an advertiser. We're all doing the same thing. So it's really this auction type of environment where it really depends also on the market conditions.

10:02I remember when the pandemic started, CPM rates dropped drastically, right? Because people were pulling advertising away, or at least stopping to some extent, because they weren't sure of the macroeconomic environment and what the pandemic is going to bring. So you could really target the users for less dollars, right? And now when you have more competition, the harder it gets, and the more costly it is, right? But still, if you look at return on advertising spend, right? It's still, I think for Google, on average, it's 200%. So it means for every dollar you invest, you get$2. And Facebook, I think the latest is around 150%.

10:37I mean, these metrics change all the time. So it really depends on what industry you are in and what you're targeting. Let's take a quick break and hear from today's sponsors. Even Einstein had blind spots. That's why modern science is built on the idea of peer review. Investing may be more art than science, but that doesn't make pure feedback any less valuable. The tricky thing is finding qualified people who are interested and willing to help vet your investment ideas. That's why we built the Intrinsic Value Community. It's a place to connect, share ideas, learn, and get feedback. Nobody ever wishes they'd spent more time buried in spreadsheets, but connecting and building relationships with others who may be smarter on a topic than you, but who are also schooled in value investing, that's valuable.

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13:23To begin getting smarter about investing, just visit theinvestorspodcast.com slash get started with stocks. That's theinvestorspodcast.com slash get started with stocks. And for a limited time, you can use code stocks15 for a 15 % discount at checkout. All right, back to the show. Yeah, you mentioned the Ukraine war and the macroeconomic conditions. It seems like the advertising space would definitely be susceptible to those macro forces. But in the long term, it's a trend that almost seems inevitable having that valuable digital real estate. Now, when I was looking into Google stock, I noticed that there are two tickers, which you don't see that very often with companies.

14:07There's GOOG and GOOGL. So these two stocks that fall under the Google's company alphabet, why are there two tickers and what should investors be focusing on? There are two tickers. The GOOG is basically a stock that doesn't have voting rights, and the GOOGL has voting rights. So this is the main difference between these two stocks. And the reason is because you see this trend for years now that founders want to keep voting power, right? So that investors, shareholders only get financial benefits, but they don't get so much to say in terms of the company because you want the company to look long term, not just short term orientation towards quarterly goals.

14:50But also interesting for Google, maybe they have another tranche of shares, which is not publicly traded. So they're kind of super voting shares. And there it's like 10 to 1 ratio in terms of one share having 10 voting rights. So they have even three tranches of shares. And maybe because you asked, what should investor focus? Honestly, if you're not some kind of activist with civilians on your head, it's not really important which one you choose. There's always the arbitrage going on. So you're probably going to see a small premium on GOGL, because they have voting rights. But in terms of if you're a normal investor, passive investor, whatever, it doesn't really matter.

15:30Yeah. I just quickly pulled up the share prices on both. When I was preparing for the interview, you. I did notice that there was a bit of a spread between the two, but now today, the class C share, which is G-O-O-G, sits at 2325. And the class A share, the other one, 2329. So it's really practically the same. And I've heard Bill Nygren, he's been on our show before. I've heard him mention that you're able to pick up the one without the voting shares often for cheaper than the other one. For me, the voting rights don't make a big difference to me. you're investing in a company, you oftentimes trust the management's judgment.

16:05They know the business a lot better than you do. And whatever kind of voting power, however they want to use those votes is all good with me. You mentioned earlier the Google's Other Bets line of business, and they're almost famous for this, even though it's not a huge revenue generator for them. What's included in this Other Bets line of business? And do you or should we expect something to come out of this? Yes. As you mentioned, ErderBets is a well-known, let's say, segment of their business, because that is where the famous moonshot factory called X is. These are these crazy ideas that Google employees have and that they mature and develop a startup incubator, if you will.

16:46And what came out of this X factory, the most important part right now, I would say is Vamo. So this is Google's kind of autonomous self-driving system. They also have other venture capital investments and private equity investments there, and also Verily Life Science, which is a research organization devoted to the study of life science. So it's really, I would say, a combination of different moonshots, but the one that kind of graduated so far is Vamo, right? If we should expect something from it, I would say in the short run, definitely not. But in the long run, Vamo definitely has potential, especially when the industry gets more ready for this autonomous vehicles and stuff like that.

17:31I see that maybe business as a potential impactful one for a company of a size of Google. And I think it's cool and it's good for Google to have this kind of laboratory, if you will, because they can discover some algorithms, AI stuff that can really help them then on other fronts. It's a fun segment, but in terms of investors, which are valuing the company right now, I don't think they give it much focus. That is interesting that they have that Waymo investment, that other bets line of business. I think that shows that they're an innovative company and they're always looking for those potential, you call it moonshot type bets, where they put down a little bit of money up front, to call it a billion dollars isn't too much money for them, but it's something that could pay off and give them just a massive revenue stream in the future.

18:18I believe they purchased YouTube for$1 billion and now YouTube produces$28 billion in annual revenue. So that's just one example of a moonshot bet that could definitely play out for them. And it's nice to see as an investor that they're looking for those types of opportunities. And when I dive deeper into Google's revenue lines, I broke down the revenue by business segment. The search line is definitely the primary driver of their revenue. The total revenue for Google is$257 billion from 2021. The search business was over 50 % of the revenue,$148 billion. YouTube was at$28 billion. Google Network,$31 billion.

18:57Google Cloud,$19 billion. And the remainder came from some of their other lines of business. As a growth investor, how do you project growth for a company like Google? And what do you expect as far as growth rates? Are you looking at the growth rates in the past and giving conservative growth rates going forward? Or how do you think about that for Google? When it comes to, let's say, the more mature business, which is search networks, you probably want to see it grow at least in line with the industry, right? I think the current estimates for KGAR for the ad industry for the next five years is around 12%.

19:33Really looking for, in terms of annual growth, is this, let's say, 10 % to maybe 20 % growth, let's say a more long-term environment. But then when it comes to segments like cloud, you really want to see growth because Google is still, if you look at the cloud space in general, they're still catching up to AVS from Amazon and Azure from Microsoft, which are much bigger, right? So they came a bit late to the show and now they're trying to solidify them as their first spot and maybe even get some market share. And that's why you want to see the growth rate of cloud being higher. So more in line with the industry, which is over 30 % and also be higher than what AVS and Azure are doing.

20:13It really depends on the segment. And I would say that, let's say for this year, we can expect a slower growth, at least in the first half of the year. And then I kind of expect growth to pick up at the end of the year back, also when it comes to their main business. And yeah, YouTube, another important, let's say, heart of the story as well. There you also want to see a bit higher growth than the industry because it still has so much potential to capture audience and it has the potential to really increase engagement and time spent on the platform. I was thinking a lot about YouTube. I don't have YouTube premium.

20:50You can get YouTube premium and not see any ads from my understanding. And I go to YouTube and just get bombarded with advertisements. Like I mentioned in my previous question, YouTube's revenue today is $28 billion. You can purchase YouTube premium for$12 a month. So I'm almost curious how they'll be able to fully recognize the full value of YouTube into the future and strategically plan in a thoughtful way how they can fully monetize this platform. So I'm almost curious if$12 a month is undercharging compared to the ad revenue they could be receiving. So what do you think about YouTube, how that might develop over the next 10 years or so?

21:32I think Google with YouTube hit the nail on the head when it comes to the strategy, because you can see just recent quarter, the streaming industry, especially Netflix, for example, they have now issues because they have this subscription only type of model, right? Where people, once they start, when you have content, they're all happy, they're all spending, right? And once you kind of don't have this next wonder, this next hit from a content perspective, right? They churn and they churn right away because they pay some amount, even if it's$10,$15, whatever they like to churn. And what's really good about the free model with advertisement is that users won't churn.

22:10If you have bad content or not so catchy content, whatever, they will engage less, but you won't lose them as a user, right? You will still keep them. And once you have better content, they'll again be more engaged on the platform. So you really want to have this. I think the whole industry will go into this mix in terms of having a subscription where you don't have to see ads and then also a model where it's free and it's only advertisement, right? And even on the subscription side, I think you will have ads when there are really viral videos or something like that, right? So when you're watching something live, I don't know, Super Bowl or whatever, or if you are watching a really well-known podcast, whatever, even if you pay, they might still give you one ad maybe, right?

22:52I think the industry will develop in this way because in the end of the day, I think people will get back used to ads like it's on classic cable television, right? Because the model just worked for years and we won't pay for every subscription service and have 100 of them, right? So I think YouTube is going in the right direction. And I also think when it comes to the younger audience, they're taking share. Them and TikTok, for example, right now are taking share away from streamers. People are watching YouTube and TikTok because they want to be entertained instead of watching a movie maybe on Netflix or Disney, whatever, right?

23:28I think the monetization will also come from higher monetization from people spending even more time on service like YouTube. Yeah, you alluded to this, but the beauty of YouTube, I think, relative to Netflix is that YouTube's users create the content for them, while Netflix continually has to invest in creating new content and people are complaining, oh, they're not creating enough content or this content is not good enough for us, we're going to go off to HBO. It seems like YouTube, similar to the search business, just has a much stronger moat than some of these other technology companies. Now, a question I really wanted to ask you is related to artificial intelligence.

24:06There's been a ton of talk over the years about AI and artificial intelligence. Elon Musk has been very vocal about AI and its potential implications on humanity as a whole. So where do you think Google sits on the AI front? And are they one of the top players in this industry? Awesome question. I think they're right at the top. And I think a lot of people don't know this because they just see the search. Again, from my previous role as the CEO of a software company, you get to see how many of these APIs Google provides, right? Whether it's an API for character recognition, for image recognition, for building AI models, they are right at the forefront of, if you're looking for a service to help you with your kind of software, you definitely look at Google's product, right?

24:54And the main advantage they have against many other players is that they have a big data set. With AI and machine learning especially, which is really important in AI, you need big sets of data for learning the algorithms. And they're the ones having these huge sets of data, whether it comes of text or images or stuff like that, even natural language processing. You're talking about Google Translate, right? Remember how Google Translate used to suck in the early days? And now it's like people are using it for even lawyers for legal writing, right? So you really see the progression and this data set of years and years that was built from also people, even from the capture, when you have to confirm you are not a robot and you click all those images, right?

25:40This is, again, you are helping Google learn. You are helping the AI model of Google learn. They're definitely at the top, but you don't see it yet in terms of revenues and stuff like that. But once this world gets more into visual AI voice, these APIs and algorithms will be very important. And also, you mentioned Elon Musk, right? He's building that robot, which has the potential to change the world, right? Because of their autonomous vehicle. Again, Waymo has similar, right? Elon mentioned that if you're building an autonomous vehicle, you basically build a robot, and it's ready also to be copied for other tasks, right?

26:19And similar, you can imagine if Waymo is building this, then it's very similar. I think we will enter the age of AI and it will really change and influence and make things more effective for a lot of industries. And Google will be definitely there. Yeah. I cannot even begin to imagine the power and market capitalization of some of these big AI-type companies later on in our lifetimes. You and I are both very young, so we'll have many years to see how this all develops. I pulled up Google stock on our TIP finance tool. And today, Google's enterprise value is only 1.54 trillion relative to just the moat the company has, how much they've grown over the years.