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The following segment was excerpted from this fund letter.
Google is one of the most extraordinary businesses of the digital age. Its mission is “to organize the world’s information and make it universally accessible and useful.” This is such a broad organizing principle for a company whose value is built on doing just that. When you think about the mass adoption of the Internet, smartphones, social and digital media, and ecommerce among billions of users every day, and the exponential growth of data that has brought, we all know how valuable Google’s role in collecting, organizing, and filtering all that information has become in our daily lives.
NVidia’s CEO Jensen Huang put the challenge really well in an interview with Tech Analyst Ben Thompson recently:
“We know that there are a trillion things on the Internet and the number things on the Internet is large and expanding incredibly fast, and yet we have this little, tiny personal computer called a phone… how do we possibly figure out of the trillion things in the internet what we want to see on our little tiny phone?
Well, there needs to be a filter in between… basically an AI, a recommender system. A recommender that figures out based on the nature of the content, the characteristics of the content, the features of the content, based on your implicit and your explicit [preferences], find a way through all of that to predict what you would like to see.
I mean, that’s a miracle! That’s really quite a miracle to be able to do that at scale for everything from movies and books and music and news and videos and you name it.”
While Huang was talking about the role of artificial intelligence more generally amidst the data explosion, it’s hard not to think of Google as most fitting the role of the Internet’s leading “recommender system,” with its de facto role as the gateway to the Internet. In fact, it’s no coincidence that Google is a leader in AI technology, which it applies across most all of its services.
To effectively deliver high performance, relevant information services, it’s a requirement to have strong competence in artificial intelligence technology and Google goes far beyond just developing the algorithms and software, as they develop specialized chips that accelerate execution to building the largest scale computing systems comprised of entire data centers. As a result of its success, Google enjoys a 90% share of all searches in the world.
The execution of its mission is demonstrated in the value Google provides to billions of users around the world with not just search but also other massively scaled and easy to use information services that consumers and businesses find uniquely useful, several times each day.
It has 9 services that have over a billion users each – Android, Chrome, Gmail, Google Drive, Google Maps, Google Search, the Google Play Store, YouTube, and Google Photos. It answers billions of search queries a day (over 3 trillion searches per year!), delivers billions of YouTube videos daily, and counts more than half the global population as consumers of its services.
Google makes life easier and better for its consumers, and for the most part for “free” – no one has to use Google’s services, but most everyone with an internet connection cannot live without it. That is how essential Google’s services are.
Its dominance is what creates its moat. In the information business, the scale of data it can gather from its huge user base encapsulating their daily activities, needs, and desires upon which it can develop and run sophisticated algorithms make it hard for new and old companies to compete. Its data scale allows its algorithmic results to be better, and the better results bring it more users and more data.
This, of course, leaves regulators who worry about a Google monopoly stuck in a bind – consumers and businesses choose to use Google’s services bringing it network and scale monopoly advantages, yet it provides huge benefit to its users, mostly for free. Traditionally monopolies are considered “bad” because they can gouge huge profits from their customers if they have no other options. But in Google’s case, it’s clear that the value it creates is mutually shared and its customers always have other, albeit less effective, options. It has power, but there’s little evidence that it’s been abused over the past two decades.
Google monetizes the insights from all that data by matching millions of businesses with billions of consumers, creating huge value for both. Merchants compete on Google’s auction style advertising platform to reach those consumers, with consumers given the option to click on ads of interest which drives the merchant’s return on investment for that spending. In this way hundreds of billions in value are created out of thin air (or more appropriately, from electrons)!
Google’s platform of services has been so effective that its revenue has grown nearly 7x from $38 billion to $257 billion over the past decade, with an incredible $75 billion added in 2021 alone. Adjusted profits surged to $84 billion from $12 billion in the decade and nearly doubled in 2021 alone. Adjusted profits exclude certain expenses like spending on incubating companies within the parent holding company Alphabet, referred to as “Other Bets,” to better reflect “core” Google profitability. The scale and rapidity of revenue growth in 2021 also demonstrated just how inherently profitable Google’s core business can be – about half of every incremental dollar in revenue dropped to the operating profit line.
This rate of growth has been possible because Google reinvests tens of billions every year in R&D and Capex, and tuck in acquisitions to support these services and build new ones. Some of these acquisitions can take years of investment to commercialize and some would have been enviable standalone businesses, yet within Google’s platform can come to fruition with its years of patience, financial support, and scale inclusive of its data trove and talent pool.
While the global behaviors around COVID helped 2021 trends, we don’t believe there will be much of a reversal as we move forward, though growth will obviously slow from the 41% observed in 2021. Google’s services are essential for merchants and consumers. Just as with Mastercard mentioned earlier, nominal spending is benefitted by higher inflation rates. Given the tight link between consumer spending and merchant ROI on advertising, we believe Google will continue to benefit from nominal GDP growth in the US and around the world.
Furthermore, scaling businesses within Google like YouTube and Google Cloud Platform (GCP) , have really found their footing in the past couple of years and have reached a size that will see them contribute meaningfully to future growth of the business. YouTube generated nearly $30 billion in 2021 and is expected to grow over 20% in 2022, while GCP generated nearly $20 billion in revenue and expected to grow 30%+ . Interestingly, the challenges of Covid and inflation increased the value of both offerings to customers, providing a natural hedge.
More nascent businesses like Waymo, the self-driving car service Alphabet has been developing for years, is finally heading towards commercialization with San Francisco as its second city launch after Phoenix. While the value of Waymo in relation to Google may seem disconnected, it’s not a stretch to see that self-driving cars would free up additional time for people to engage with Google properties while leveraging and contributing to its AI expertise and cloud infrastructure. Our team recently took a couple of Waymo rides in Phoenix and SHARED the experience on Twitter.
We believe the future continues to be bright for the assets Google has developed and that its opportunities ahead continue to be very strong as information and computing-based services innovation continues to drive increasing value globally. Yet despite its long history of innovation and growth and the strong stock performance since 2019, up 100% vs 40% for the S&P 500, valuation is still very reasonable because its earnings (including the losses in the Other Bets division) have more than doubled from $48 in 2019 to $100 in 2021 and $125 estimated for 2022.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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