There are not that many things needed to make a business truly successful over the long run. Yet it can be difficult for one firm to have them all. And I think Google and YouTube parent Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) is set for ongoing success. Alphabet stock is well below the $100 mark, after losing 28% of its value over the past year. Lately I have been buying it for my portfolio.
So, why do I feel Alphabet has what it takes to be a great business not just now but in the long term?
Large target market
The market for the sorts of services Alphabet provides is already massive – and I expect it to stay that way. Demand for things like cloud hosting and email provision is set to hang around for decades, in my opinion.
What about search, the jewel in the crown? I do see some risk here – AI services might serve up information people need without them having to search for it. That could potentially reduce the massive advertising sales that fuel Alphabet profits.
But I look at that another way. Google’s mission has long been about organising the world’s information. So far, search is the way it has done that most obviously. But I think it can use AI or other innovations to match its delivery model to the moment. In the long run, I expect Google to remain a market leader in the real business of search: connecting users to information.
Competitive advantage
Other companies compete in similar areas. They are impressive rivals too, like Microsoft and Amazon. So what sets Alphabet apart?
I think the pie is big enough that it can be divided among multiple players and stay lucrative for each. I reckon Amazon, Alphabet and Microsoft could all make vast profits in future from cloud computing, for example.
But I also think Alphabet has some strong competitive advantages. Its brands, huge user bases, technical capability and patent library help set it apart. They also help to keep users loyal.
Monetisation and cash flows
One thing that puts me off a lot of tech stocks is a lack or profits.
To be a good business over the long term, a firm needs to make profits – and also have cash coming in the door. Accounting profits are good, but free cash flow is the oil that greases the business engine.
The firm’s most recent quarter was widely seen as a disappointing one by investors, who have marked Alphabet stock down accordingly. But the business reported net income of $13.6bn and free cash flow of $16bn. Those are huge numbers for a single quarter. To my mind, they underline just how attractive Alphabet’s business model is.
I’m buying the stock
But a great business does not always make for a rewarding investment. After all, if I had bought into the firm a year ago, I would now have a significant paper loss.
What about the valuation today?
The market capitalisation of $1.2trn sounds huge. But with net income last year of $60bn, the price-to-earnings ratio is only around 20.
In the long term, I think Alphabet’s strong business features could help it grow income, perhaps substantially. So I think the current Alphabet stock price is a great buying opportunity for my portfolio. I’ve been seizing it!
