Clay Finck (02:53):

So, not only is Google gaining market share, but the overall pie is getting bigger and bigger for them each year, as this secular trend from traditional advertising methods to digital advertising really takes hold. Another item I really like to look for in the companies I invest in is for the company to have a track record of return on invested capital being greater than 10%. Given that Google’s cash flows have grown substantially over the years, it should come has no surprise that they have a great return on invested capital. According to our TIP Finance tool on our website, return on invested capital has been over 20% over the past decade. If they can continue to have high return on invested capital like they have, then long-term investors should expect Google to deliver strong returns to shareholders. If you’d like easy access to TIP Finance, you can just go TIPstocktools.com and it will get you directed to that tool.

Clay Finck (03:53):

Moving along, Google also has an exceptionally strong balance sheet. They have $134 billion in cash and cash equivalence, and their long term debt is only $14 billion. Any sort of downturn in revenues or earnings, Google will most certainly be able to weather through. Also, having this amount of cash allows them to make purchases of companies that they believe can further improve their current business or potentially be a huge success in the long term future. Google has made a ton of acquisitions since they’ve gone public. Most notably, they purchased YouTube for $1.65 billion in 2005. As I mentioned in the mini episode about investing in tech companies, Alphabet owns a number of different business segments with over one billion users, giving them opportunities to grow revenues and earnings outside of just Google search, which currently drives most of their earnings today. One of the most important things that Adam Ziesel pointed out to look for in a company was to ensure that the company has a very strong moat.

Clay Finck (04:56):

And Charlie Munger is even quoted saying that “Google has one of the strongest moats he has ever seen.” Adam Ziesel mentioned during my conversation with him that Microsoft spent $15 billion on Bing, trying to compete with Google search, and they just couldn’t do it. Google just completely dominates the search space. One newsletter I’m subscribed to is written by someone under the name of Value Stock Geek. He had a brilliant write up on Google that digs more into the moat and just how powerful it is, as well as his overall analysis of the company. I really enjoyed reading up on it, so I’ll be sure to link that in the show notes for you guys if you’re interested in checking it out. I found it really valuable myself. With both Google and YouTube, Alphabet absolutely dominates the global search market in both text and video. Android is also a really valuable asset that Alphabet owns with over one billion users that has a really strong moat.

Clay Finck (05:54):

As far as management goes, I like to think that Alphabet’s managers think long term and put the investor’s best interest in mind. With the way the stock has performed over the last 10 years, it’s hard to think that managers aren’t working in shareholders’ best interest. They invest in many of these moonshot projects that have the potential to be massive revenue generators many years into the future. Waymo’s a good example of this, which develops technology for self-driving vehicles. Google Fiber is another example, which attempts to provide fast internet access. It’s likely that some of these moonshot bets will pay off big time to help fuel future growth for the company. Having that strong balance sheet and the increasing revenues allows them to continue to invest in these long term projects. And of course their free cash flow growth and share price appreciation has been just phenomenal over the past decade. Over the last decade, Google stock has appreciated at 21.2% per year.

Clay Finck (06:52):

Your winners tend to keep on winning is almost my thesis with Google. Related to the moonshot projects I mentioned, Google has been just plowing money into research and development. In 2013, their R&D spending was $7 billion. And in 2021, that spending is now up to $31.5 billion, which is more than both Apple and Facebook when looking at some of the other tech companies out there. Now let’s get to our intrinsic value assessment of Google, now that we know that it’s a really strong company. Let’s look at the numbers and see what we can expect for an expected return. I’m going to be using our TIP Finance tool to determine what sort of return I would expect from Google at today’s price. Again, if you want to check out TIP Finance, you can just go TIPstocktools.com and I’ll be using the tools on there to determine my own expected return.

Clay Finck (07:45):

Now, one of the first things I see in our TIP Finance tool when I look up Google is that many of what we call legend investors own the stock. I see seven investors listed in our legend section. Guy Spier for example, has a 1% position in Alphabet. Michael Burry has a 9% position. Bill Miller, 3%. Bill Nygren, who I’ve had on the show has nearly a 10% position. So, seeing that many of the greatest investors in the world own this stock is a great sign to begin with as a retail investor. One of the most important assumptions to input into the tool is the free cash flow earnings to start with today, as well as the assumed growth rate over the next 10 years. I’m going to use their trailing 12 month free cash flows as my starting point, and to determine the assumed growth rate, I’m going to take a look at some of the historical figures. From 2012 through 2016, we saw substantial growth in the free cash flows from $2 billion, up to $26 billion.

Clay Finck (08:44):

Then they kind of stagnated a bit from 2016 to 2019 as they grew from $26 billion to $31 billion. Then with the COVID pandemic, revenues in free cash flows absolutely exploded for Google. Free cash flows grew from $31 billion in 2019 to $43 billion in 2020 to $67 billion in 2021. This makes it really difficult to project these out in the future as might be extended a little bit. But I think a lot of this revenue will be sticky and over the long term, their business most definitely will continue to grow. The trailing 12 months free cash flow is $65 billion and their current market cap is around 41.54 trillion. Dividing the free cash flows by the market cap, we get a free cash flow yield of 4.2% after subtracting out the excess cash of $120 billion off the balance sheet from the market cap, that would give us a current free cash flow yield of roughly 4.6%.

Clay Finck (09:43):

So, to have one of the best businesses in the world yielding almost 5% right off the bat is pretty attractive to starting our analysis, given that they are growing so fast and still have a really long runway ahead of them. Theoretically, if free cash flows were to grow at 15% per year over the next three years, that would bring the free cash flows to $99 billion, which would give us a free cash flow yield of 7% based on today’s market cap, excluding excess cash. That’s one thing that Adam likes to do in his analysis is to use a reasonable growth rate over the next three years or so, and to see what your yield would be on the company. Now, what I would want to do is access the IRR Calculator in our TIP finance tool. Essentially what this does is project out the cash flows into the future and gives you the investment return you can expect based on the free cash flows, assuming that you purchase the stock at today’s price.

Clay Finck (10:39):

To find that IRR Calculator, I simply scroll down a bit on the fundamentals tab of TIP Finance in the intrinsic value section. There’s a little calculator you can click to pull up the IRR Calculator. And for those not familiar, IRR stands for Internal Rate of Return. So like I said, first on need to input an expected growth rate for Google over the next 10 years. To get an idea of what we can expect going forward, we can look at what we’ve seen in the past like I mentioned, as well as what the overall industry is growing at. I mentioned earlier that the digital advertising space is growing at around 11% per year. I personally think of 15% growth rate is pretty reasonable for Google. It is slightly higher than what the overall industry is expected to grow at. So, this assumes that Google will maintain their competitive position in the space, as well as utilize their economies of scale to help minimize cost as they grow and scale their business units.

Clay Finck (11:36):

So, essentially I expect the revenues to grow faster than the expenses, which means they will become more profitable over time. Next, I need to input my starting point for future free cash flows. So, I’m going to just use the trailing 12 months number and their financials, which is $65 billion. I’m going to leave the shares outstanding field as is, which is 13.17 billion shares, as they just recently had a stock split. If we were to buy the stock today at $117.47 cents and today is Monday, August 8th at the time of this recording it’s being released. A few days after this, we would expect a 9.9% annual return. Considering that the 10 year treasury rate today is 2.8%, this seems like a fairly attractive return in the stock market given the current market conditions. Next, I wanted to tweak a couple of the assumptions to see how the expected return changes. Let’s say that instead of growing at 15% per year over the next decade, they grow at 10%.

Clay Finck (12:39):

This changes the expected return in our calculator from 9.9% down to 7.0%. So, as long as Google is able to maintain their competitive position in their larger business units, and they capture the growth in the digital advertising space, which is around 11% or 10% per year, I would expect us to at the very least receive a 5% to 7% return over the next 10 years. And that’s very, very conservatively. I believe that’s a very reasonable assumption that they’re going to grow at 15% per year, given how strong their mode is and just the competitive position they have in the marketplace. Another tweak I wanted to make just to stress test our analysis a little bit, I wanted to see how the expected return changes should we see a further pullback in the stock price. Changing the expected growth rate back to 15% like we originally had it. Lets imagine the stock decreased by 20% from today’s price of $117.47, multiplying that by 0.8, which is a 20% decline. This will bring the stock price down to $93.98 cents.

Clay Finck (13:48):

Inputting this as the market price in our tool, this increases the expected return from 9.9% up to 12.1%. So, assuming that the business isn’t fundamentally changing and the long term thesis of the business is still intact, then we should be taking advantage of any price drops in Google’s stock, given the investor wants to increase their position size in the company. And this is just to help give us an idea of okay, how does our expected return change should we enter something like a depression type scenario, and the stock really gets hammered as well as the overall market? So, instead of getting a 9.9% expected return today in the stock price decline to $93.98 cents, we would expect a 12.1% return. Given that the assumptions in our model don’t change at all. Another item I like to look at is the Enterprise Value to EBIT ratio and how that’s really changed over time. Currently this ratio sits at around 17.5, with the exception of earlier in 2022. This ratio hasn’t been this low since 2012. The only time this ratio dipped below 15 was during the 2007, 2008 Great Financial Crisis.

Clay Finck (15:02):

So, unless we see a substantial pullback in the free cash flows, which I don’t really expect we will, there seems to be a really good margin of safety built into Google’s current valuation. I would personally expect Google stock to compound at around 10% per year or more conservatively. And this isn’t expecting any outlandish growth assumptions and Value Stock Geek in his article also comes to the same conclusion that he expects the stock to compound at 10% or more per year for long term investors. All right, that’s all I had for you guys for today’s episode. If you agreed or disagreed with my analysis or have any feedback, I’d love to hear from you. Feel free to reach out to me on Twitter, my username is at clay_finck, that’s at C-L-A-Y, underscore F-I-N-C-K. I’m also starting to post some content and reels on Instagram. So, feel free to give me a follow there. I’m at the username at clay.finck. Thank you guys so much for tuning in today. I really appreciate all the support you guys have given me. It’s been a lot of fun doing this analysis. Thanks a lot for joining me.

Outro (16:11):

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