hi I'm Jimmy in this video we're looking at alphabet Incorporated ticker symbol
goog and googl yes they have two but we'll come back to that in a minute okay
our goal with this video is to try to take a basic look at alphabets business
and then try to see if we can determine the fair value of Google's stock okay
now now I'm sure we all know that alphabet is Google so from here on out
I'm just gonna call it Google okay so how about we start at the basics of
Google's business so Google breaks their business into two main segments they
have Google and then they have other bets now I'm not sure why they do it
this way because this is the way their chart ends up look so as we could see
using 2018 revenue the Google segment represents ninety nine point six percent
of all revenue so Google classifies other bets as emerging businesses that
are in various stages of development and in theory they're in large industries
that have huge upside potential if they work out but they're small right now so
they don't really affect what Google's doing all that much now when we jump
over the Google segment now here they do go one step further and break it into
Google properties and Google Network member properties so this does give us a
bit more color there not too much more so in the Google properties they have
lines of business like google.com or YouTube or Google Maps or the Google
Playstore and things along those lines the Google Network member properties
well that's where revenue from external sites go usually using platforms like
AdMob or Google Adsense and clearly the Google Network member properties isn't
as big as Google properties themselves but they're still quite large they
generate just short of about twenty billion dollars in revenue in 2018 while
Google properties generated about a hundred billion just short of a hundred
billion last year okay so before we try to come up with a fair value for Google
stock let's look at why they have two different stock tickers so Google stock
is actually broken into three different stock classes they have Class A Class B
and Class C these are the number of shares that are
available for each of those Google stock classes I've rounded them but they're
close now we'll see in a second it's not gonna matter all that much anyways
so there used to be just two classes of Google stock they had Class A and Class B
then back in 2014 Google split Class A into two different groups Class A and
Class C Class B shares are not publicly traded they're the ones that are mostly
owned by Larry Page and Sergey Brin of the founders of Google okay simple
enough but here's where things get somewhat interesting so as we know when
we buy shares of a public company well we become a part owner of that
company and one of the benefits of ownership is generally we get to vote at
the annual shareholder meeting we get to vote for things like who's on the board
of directors in high-level items like that
well some companies that doesn't exactly work out that way Google is one of those
examples of where it's a bit different here so Class A shares well they get one
vote for every share that they own simple enough
that's typically the way it works with most stocks okay then Class B well they
get 10 votes for every share that they own so right away we can see that the
Class B shares get the majority of the votes and we can't forget that Class B
shares are not publicly traded we can't we can't get those shares and then Class
C well they don't get any vote at all so Class A shares are represented by the
ticker goog L and Class C shares are represented by the ticker goog and if
we're curious this is a chart of Google stocks above both shares a and C
side-by-side and as we can see they look pretty much the same they're very close
to each other as of last I saw they were about a dollar apart so they're moving
virtually side-by-side now we may ask if Class A gets voting rights and Class C
doesn't get voting rights why isn't class a more expensive and the real
answer to this is that it doesn't matter all that much anyways because Glac Class
B ultimately controls the company page and Brin can't be out voted so what's
the difference if we own Class A or Class C now personally I think that
these two share classes are not equal I prefer Class A shares of a Class C but
here's why so Google has a buyback program and
generally when they're doing their buybacks they're buying back Class C
shares in fact Google bought a back about twenty-two billion dollars worth
of stock of Class C shares in the past five years so we might say okay great
that sounds like a decent thing for Google stockholders or at least Class C
stockholders don't forget goog is Class C but when we
look at the shares outstanding today versus the way they were in 2015 for the
Class C shares well they're actually more shares now despite the fact that
they've bought back twenty-two billion dollars worth of stock why you asked
well generally employee stock options and if cup of Google were to make an
acquisition well those are Class C shares that are getting issued so
essentially all of the buybacks all they're really doing is offsetting the
Google stock options or the employee stock options and in the acquisitions
that the companies make now I bring this up not because it's a huge deal mostly
because I want us to be aware that if they ever stopped those buybacks
well the shares are likely to continue to be issued and that could ultimately
drive the price of the two stocks a bit further apart where I think Class A
shares will prove to be a bit better at that point but that's just my opinion
okay so let's dive quickly into the financials and then we'll try to come up
with a fair value for Google stock so this is Google's revenue and as we could
see they've done a fantastic job of growing revenue over the past five years
or so they've had a compounded annual growth rate of about twenty percent so
it's been fantastic growth overall for Google stock now when we jump over to
profits well here we could see that Google's net income is once again quite
good except for the noticeable dip back in 2017 this dip was due to changes in
the US tax law and Google had to add on a tax bill of about nine point nine
billion dollars that's why you see that dip in profit there how about margins
well when we jump over to net income margins we could see that after 2003 and
2004 net income margins have been fairly solid in the 20% plus area for a while
in fact if we calculate the average over this time period we could see the
average o average net income comes in at slightly better
than 21% how about free cash flow once again Google's done a pretty good job of
maintaining solid free cash flow and I know for anybody who's been in this
channel before knows that I'm a big fan of using discounted cash flow to try to
value a company's stock so how about we try DCF for Google stock right now
so this is a result of the discount of free cash flow analysis that we've done
for Google stock now if you're wondering how to do this type of analysis I
actually have a full step-by-step guide as to the exactly what you need to do to
come up try to come up with this fair value so if you're interested in try to
come up with this fair value on your own while I created an excel template it's
free it's there's a link in the description below
to that website just throw in your email address and I'll send it over you okay
so I'm gonna run through these numbers real quick and then I want to bring out
something that tripped me up when I was first starting to research Google stock
okay so these are estimates and I took these from analyst estimates that I
could find so for the required rate of return I actually used 8% now this is a
bit lower than I typically like to use but Google has a fairly strong balance
sheet and in theory a stronger company would require a lower required rate of
return so for me it made sense to use this for Google stock I think eight
percent is a bit better than the eight and a half percent that I typically like
to use usually I'll use eight and a half to nine percent eight percent I think
makes sense for me here now one point regarding the strength of Google's
balance sheet for anybody who was been watching Google stock we may have
noticed that there was a big jump in their long-term debt so this is a
quarterly chart of long-term debt going back the past couple years and as you
may notice there's a huge jump in the first quarter of 2019 but when we done
it bit deeper it turns out that this jump was actually from an accounting
change that Google adopted in the beginning of 2019 with this accounting
change some leases are now accounted for as both an asset and a liability hence
the reason this liability shows a giant jump now it's somewhat irrelevant
because when we add cash and cash equivalents and short term investments
to this chart we can see things have gotten the the things
significantly better it's somewhat irrelevant whether they have 14 billion
in debt or 4 billion in debt with the amount of cash that they're sitting on
ok jumping back to our DCF calculation next we used a perpetual growth rate of
about 2.5 percent it's typically where I like to be between two and two and a
half percent well that gives us a fair value of the stock I've bought 1454
that's of course assuming we believe the analyst projections and we agree with
the discount rate and our perpetual growth rate now when I first did this
analysis I actually got tripped up because of the shares outstanding and
when we go over the Yahoo Finance and we pulled their statistics page well this
is what we're gonna see and I came across two shares outstanding simple
enough and for some crazy reason I simply copied the shares outstanding
into our excel template and got a fair value result of something like 3,300
dollars per share now yes DCF valuation or any valuation for that point is just
an estimate but that would be way off considering where the current stock
price is so it turns out that these stock the share class difference that we
talked about before well that is playing a huge role in our
valuation right now see this is goog L and it has about 300 million shares
outstanding and then if we jump over to goog there we can see that's an
additional 340 million shares outstanding now there are also Class B
shares and those should be included in this whole mix as well so when I did the
DCF valuation I added all three together to come up with the proper number of
shares outstanding now if you're looking for the most accurate way to get these
numbers instead of jumping from Yahoo Finance or wherever whatever site we're
using the company's most recent 10k or 10 Q generally on the first a second
page will have the numbers listed as of the end of that quarter or annual number
whatever it is those are generally the most accurate numbers to use those are
the numbers I used for our DCF valuation okay so based on where Google's stock is
currently trading and our calculation of discounted cash flow Google's growth
they have solid net profit margins they have a very strong balance sheet I
actually think that Google could make a good addition to a lot of value
portfolios and maybe even it's a few both portfolios I think right now they
seem fairly reasonably priced now their p/e ratio is a little bit high it said
about 24x versus the S&P which is about 18 X or 19 X so it's a little on the
high end but given its overall situation given how strong the company is I think
it deserves to be up where it's at possibly even higher but what do you
think do you agree that Google stock looks pretty good pretty attractive at
this price right now please let me know what you think in the comments below
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see in the next video thanks