A Fracturing Search Market and Lack of Monetization Will Slow Revenue Growth

• The company grew above expectations, with the cloud being the primary driver.
• Profitability improvements have vastly surpassed my expectations, leading to a valuation upgrade.
• Google will continue reinvesting in capex, which will sustain long-term growth
• Google maintained its search dominance, improved operations from within, and is scaling revenues from its main growth avenues.

Google Keeps Winning In Cloud

• Google grew Q3’24 revenue 15% to $88.3B. Cloud was a large growth driver, increasing 35% to $11.35B. 
• Search still accounts for 56% of revenues with $49.4B.
• Advertising revenue was $65.85B up by 15% YoY.

On a trailing 12-month basis, Google’s revenues reached $340B, up by 14% from the prior TTM period. This is on track to reach my $350B estimate by the end of 2024. In the last 5 years, Google has grown revenues at a 7.3% CAGR, putting it slightly below my forward estimates for a 10% CAGR. Part of this growth was organic, and part of it was inflation-driven nominal growth. While I still anticipate that Google will keep its organic growth, I estimate that pricing increases will not be able to contribute to future growth, and expect that future growth rates above 10%-13% will be the exception, not the rule.

While Google has many growth avenues still available, I feel that the absolute basis of $340B in revenue will be a limiting factor to what the company can build upon. Despite this, I am still maintaining my future revenue growth estimates of 10%, and extending my forecasts to 2029 with a target revenue of $550B.

Alphabet Has Successfully Scaled Profits

Net income increased 33.5% to $26.3B or $2.12 per share. In the last 12-months, Google has made a net income of $94.3B, topping my estimates. 

The company managed to scale profitability much faster than I anticipated, which has been reflected in the share price. This represents a profit margin of 27.7%, vs my estimate of a 20% margin in 2028. 

After a wave of optimization and restructuring, the company has demonstrated that it can focus on producing value and increasing margins. I expect profitability growth to continue, and am upgrading my margin estimates to 30% in 2029. This implies a future net income of $164B. I believe that Google will keep scaling up in the next 5 years, however, I also expect competitors to start looking towards Google for best practices, and build-up their own competitive barriers, limiting Google’s further expansion.

The company has returned a combined total of nearly $70B in buyback and dividends, resulting in an adjusted yield of around 3.4%, indicating that the value of Google still lies in its future growth as opposed to its current earnings power. Despite this, Google is likely the most fairly-priced company today out of all of the top tech companies.

Reinvestments Will Continue Yielding Growth

Google increased its CapEx spend $13B. Most of the spend was related to servers, data centers, and networking. This is expected as Google is building up proprietary capabilities in AI. In the last 12-months Google marked $49.3B in CapEx, peaking in Q2’24 with a $13.186B spend.

For a cash-producing company like Alphabet, having the opportunity to invest in infrastructure hardware can be a decision-making relief as the investments can yield clear performance and cost-saving benefits.

I believe that Google’s future growth will be driven by CapEx and the company will continue investing to meet its goals. Going forward, I expect Google to maintain and slowly increase its reinvestment to an annual rate of $50B by 2029. Not all of this spending will be related to infrastructure and some of it will likely include smaller tech acquisitions.

While optimizing efficiency was a key challenge for Google in the past few years, I see the deployment of CapEx as a new front in the upcoming period. Besides AI, Google has to advance its media platform (YouTube), keep defending search, drive innovation in cloud infrastructure, and scale device sales. All of these are high-potential avenues, but the company is already on the cutting-edge and will need specialized innovation that may have to be nourished for many years before producing results. Additionally, the company is in the crossfires of the FTC, which is limiting Google’s expansion-via-acquisition capabilities.

In the earnings call, the CEO noted that more than 25% of the internal code in Google is now written by AI and reviewed by engineers. By his estimate, this allows the teams to build more and move faster. In my view, the KPI on whether the AI investments are truly productive is the revenue per employee on a 2 to 3 year average basis measured at least 1 year after the restructuring. We still need to wait for the data on this to mature, but I suspect that the company is moving in the right direction, and will overcome present-day criticisms.

Valuation Upgrade

While Google will likely keep growing in the future, I also expect its growth opportunities to decrease as time goes by. For this reason, I think that the future PE, which I estimate at 25x in 2028, will converge down to 21x in 2029.

With my new $164B estimated earnings and a 21x PE for 2029, I estimate a future value of $3.48T for Alphabet.

Discounted back to today, using a 7.1% rate, I get a present value of $2.5T or $217 per share.

Despite the relatively low revenue growth rate in the past 12-months, Google has demonstrated that it managed to improve the organization from within. This is visible in the bottom-line growth from $60B when I first published my narrative in 1H’23 to $94B in the last 12 months. I expect that this operational efficiency will continue in the period ahead.