[00:03:27] Shawn O’Malley: This will not be an easy company to estimate intrinsic value for, but I’m excited to go through a few different frameworks for valuing this gargantuan collection of businesses that billions of people interact with every single day. With more than a 2 trillion market cap and over 180, 000 employees, Alphabet is about as big as it gets for a private enterprise.

[00:03:48] Shawn O’Malley: And I almost don’t know even where to start with a company whose services are so ubiquitous. Perhaps though, I’ll start with some insights from one of my favorite investors to follow Adam Seessel discussing alphabet Seessel and investment manager and author of the book, where the money is value investing, the digital age says the following. Let’s take a listen.

[00:04:07] Adam Seessel: Look, you know, the money is where it’s always been in the sense that it’s always been in superior businesses. You know, Peter Lynch said a generation ago that. In the end, superior businesses win, and those, uh, those victories will be reflected in the marketplace. It’s just that in the early 21st century, most of those moated businesses, to use Buffett’s phrases, are in tech.

[00:04:32] Shawn O’Malley: Seessel has been a guest on our podcast in the past, and I really do recommend reading through his book if you haven’t already. It makes a pretty strong case for how value investing needs to be updated for the 21st century.

[00:04:43] Shawn O’Malley: But without going on too much of a tangent, I have to admit that Seessel’s thinking on companies like Alphabet is what convinced me to look at big tech more seriously. Obviously, we are by no means early to the party, but I guess better late than never. To take a step back, though, let’s get sort of a 30, 000 foot view of the business.

[00:05:01] Shawn O’Malley: In 2015, the company formerly known as just Google became Alphabet, drawing in part from Warren Buffett’s holding company, Berkshire Hathaway, as inspiration. Former executive Eric Schmidt encouraged Google’s co-founders Larry Page and Sergey Brin to embrace the more decentralized management structure of Berkshire and even to directly meet with Buffett in Omaha to study how he had empowered so many excellent CEOs to run their subsidiary businesses.

[00:05:28] Shawn O’Malley: In late 2019, Page and Brent stepped down to allow Sundar Pichai to take over as a conglomerate CEO, but they’ve stayed on the board of directors and continue to have controlling voting power over the company. When I look through the list of subsidiaries that make up Alphabet, it’s a bit longer than I expected.

[00:05:45] Shawn O’Malley: Across its network of subsidiaries, Alphabet actually has more than a dozen CEOs and co CEOs with Google at the center led by Pichai. The core Google subsidiary is the one we all know best and includes, of course, the search business, as well as Android’s operating system, Gmail, Google Calendar, Google Docs, Google Photos, Sheets, Google Translate, YouTube, Google Earth, the Chrome browser, the Google Play Store, and hardware products, too, like Chromebook computers and Android products, and smart speakers and smart home appliances tied to the Nest brand.

[00:06:18] Shawn O’Malley: And that’s just a sampling of things tied to the Google subsidiary, specifically under the alphabet umbrella of businesses, not directly run by Pichai or Calico, a health research company devoted to overcoming diseases related to aging capital AG, a private equity investment firm with 7 billion in assets under management focused on building stakes and growing tech companies like Duolingo and Credit Karma, which have both been recipients of investments from capital AG in the past.

[00:06:46] Shawn O’Malley: And then there’s Google Fiber, a broadband high speed internet provider with hundreds of thousands of customers and GV, formerly known as Google Ventures, and which should not be confused with Capital AG, which is focused on later stage growth companies. According to GV’s website, quote, with Alphabet as our sole limited partner, we focus all our energy on meeting and supporting founders at the earliest stages of company building.

[00:07:10] Shawn O’Malley: Today, GV has over 10 400 active portfolio companies across North America and Europe, and notable investment outcomes including Uber, Nest, Slack, GitLab, Duo Security, Flatiron Health, Verve Therapeutics, and One Medical. So that is pretty impressive, but we also can’t forget about isomorphic labs. A firm focused on using AI to discover new types of drugs, Verily, a research firm devoted to researching life sciences technology, Waymo, Google’s self-driving vehicle division, and Wing, a drone delivery company.

[00:07:45] Shawn O’Malley: In fact, if you live in the Dallas Fort Worth area, you can actually use Wing to have your groceries delivered by Walmart in apparently 30 minutes or less, and the technology is so precise that they claim they can deliver hot coffee without any spillage. And last but not least is X, best known for being where Google tests it’s truly moonshot ideas that aren’t even really expected to be viable.

[00:08:06] Shawn O’Malley: Depending on your perspective, people tend to either see it as a wasteful use of money or an important part of what makes Alphabet so special. The moonshots division is premised around using Alphabet’s resources to discover disruptive technologies that are too exotic for others to consider. And it got its start by working on the company’s first prototype for self-driving cars.

[00:08:26] Shawn O’Malley: It would later become the basis for Waymo in 2016. This division is also responsible for initiatives like Google Glass, which were high tech glasses with augmented reality capabilities built into them, Loon, a project meant to deliver internet to remote areas using networks of interconnected high altitude balloons, And a bunch of other similarly ambitious projects.

[00:08:46] Shawn O’Malley: And that hardly touches on all the subsidiary companies and projects that have been spun up and wound down over the last few years either. To say there is a lot going on at Alphabet is an understatement. If I had to put it in a nutshell, Alphabet is firstly a search company, which is arguably one of the most profitable monopolies in modern history, since Google essentially knows what every single person is searching for or has recently searched for.

[00:09:09] Shawn O’Malley: And that gives them the data and power to sell incredibly valuable advertising real estate for any type of search you can imagine. That success has enabled Alphabet to compete with Apple in the world of smartphones, tablets, and computers, while also building YouTube into a content giant that rivals Netflix in longer form videos, Spotify and music and podcasting, and TikTok and Instagram in short form videos.

[00:09:31] Shawn O’Malley: To say nothing of the fact that YouTube TV is now encroaching on the business models of traditional cable television, especially with access to live sports. YouTube TV actually includes cable channels like ESPN, NFL Network, FOX, Comedy Central, Food Network, and MSNBC at a pretty reasonable price. And then there’s YouTube Premium, which gives subscribers access to all of YouTube ad free for just 14 a month, as well as the regular old free version of YouTube, which the company monetizes by overseeing a massive ad network and taking a chunk of those ad dollars as fees while paying out the rest to creators.

[00:10:04] Shawn O’Malley: On top of all of that, Google Workspace has its whole suite of productivity tools that it offers as free alternatives to services like Microsoft Teams, Zoom, Microsoft Word, and Excel. That wasn’t enough industries to successfully disrupt. By investing in Alphabet stock, you also get its world class private equity and venture capital funds that I mentioned a few moments ago, which give you exposure to the next generation of innovators and its own in house bets that we’ve talked about too that include biotechnology, drones, and robotics.

[00:10:33] Shawn O’Malley: Thanks. With Waymo, let me just say that if you’ve ever ridden in one, I’m definitely jealous because I’ve heard that they’re absolutely incredible. Accordingly, Alphabet is very much a leader in self-driving cars, and that positions it to compete directly with Tesla, while massively disrupting Uber and Lyft, too.

[00:10:48] Shawn O’Malley: Imagine, after a night out, ordering a self-driving Waymo car to pick you up. It’s a fraction of the price of regular Ubers, since there’s no human labor, and is also safer from both a driving perspective and from the fact that you’re not trapped in a stranger’s car. I know Waymo and Uber have partnered together in some ways, but still, that’s a hundred billion dollar plus industry that Alphabet will flip upside down, probably, and yet that’s hardly even one of the most exciting things the company is either already winning at or in the process of developing.

[00:11:18] Shawn O’Malley: We’ve really spanned the gauntlet of the world’s most valuable businesses, and Alphabet as a conglomerate is some blend of all of them that, in total, is probably greater than the sum of its parts. When I see Alphabet, I see Google, but I also see elements of Apple, Microsoft, Spotify, Tesla, Uber, Zoom, Live Sports, Cable, and TikTok.

[00:11:38] Shawn O’Malley: And that leaves out the elephant in the room, which are its massive AI initiatives around Gemini that are meant to challenge OpenAI’s chat GPT. Truthfully, we don’t have anywhere close to enough time to really zoom in on any of these businesses and projects in as much detail as I’d like to, but I hope to paint a picture that makes things more digestible.

[00:11:57] Shawn O’Malley: Especially if you want to build on the work, I’ve done in this episode to understand the company and dive in even further yourself. Before I forget though, I do want to tie a bow around all these different areas that Alphabet successfully competes in by just reading off some breathtaking stats about the company.

[00:12:13] Shawn O’Malley: Google is the most visited website on earth, thanks to controlling 92 percent of the search engine market, with over 9 billion searches made on Google each day, and over 4 billion users. Every second, roughly 100, 000 searches are made, filtering through an archive of over 40 billion webpages. YouTube, in its own way, is a search behemoth, too.

[00:12:35] Shawn O’Malley: YouTube has well over 2 billion active users, with more than 50 percent of American adults visiting YouTube every single day, while globally, people watch more than 1 billion hours’ worth of content every 24 hours. Roughly 400 hours of content are uploaded to YouTube daily, so you can imagine how much content YouTube search feature has to dig through to present what you’re likely to be most interested in.

[00:12:58] Shawn O’Malley: Over 1.5 billion people also use Gmail, while Google Maps contains 21 petabytes of satellite imagery of the planet, which for context is the equivalent amount of storage as 330,064 gigabyte smartphones. And here’s another really crazy one from 2013. For five minutes, Google was unusable. As a result, global internet usage fell by 40%.

[00:13:22] Shawn O’Malley: We also shouldn’t forget that there are over 3 billion monthly users of the Android operating system, as Android controls about 70 percent of the global operating system market for mobile devices. I could keep rattling off stats like that for probably the next five minutes. But I think you get the point.

[00:13:37] Shawn O’Malley: It’s not lost on me that as a research alphabet, I’ve gone back and forth between Google Docs, Google Sheets, Google Drive, and Google Search, all while using Google Chrome and watching YouTube videos about the company. So that just really speaks for itself. Google is such an integrated part of my life that I had to stop and think about all the different touch points I have with Google services.

[00:13:57] Shawn O’Malley: There’s probably some more subtle ones I’m overlooking as well. This isn’t like TikTok, which has just one platform with a massive user base. Alphabet has dozens of services with billions of users, and that is just unfathomably valuable. But that raises a question that I knew I really wanted to better understand when I first started studying Alphabet, and that is, how does Alphabet monetize all these seemingly free services it offers?

[00:14:22] Shawn O’Malley: I know all the mumbo jumbo about data and advertising, but I wanted to wrap my head around this even more. Personally, I can’t really remember paying Google directly for anything, since I use the free versions of all of its services, including YouTube, and all my devices are from Apple. From what I understand, there are a few different ways it generates revenues from seemingly free services.

[00:14:41] Shawn O’Malley: Obviously, with YouTube and search, these are ad supported. You watch a video and several ads play throughout. That’s pretty straightforward. Same with search. You look for dentists in your area. The first few results will probably be sponsored, where local dental practices have paid to have their business suggested first.

[00:14:57] Shawn O’Malley: You can imagine that works across geographies, product types, keyword searches, and more. Google is pretty clearly selling off their digital real estate at the top of its rankings and for the most part, no one really minds that they do. Sometimes I find sponsored results slightly annoying, but never to an extent where I seriously would consider switching to another search engine.

[00:15:16] Shawn O’Malley: Beyond including ads in search, Alphabet also has its AdSense marketplace, where websites can enroll to basically enable Google to display ads across their website. And advertisers bid on that inventory while Alphabet collects a fee from that and pays websites a share of revenue based on the number of clicks they deliver.

[00:15:35] Shawn O’Malley: But then when it comes to productivity tools like Google Docs, Sheets, Calendar, and Meet, these are all part of Google Workspace. The free features are incredibly powerful, but businesses can pay for a few different plan options that range from 6 per month to 18 per month or more for an enterprise level subscription.

[00:15:52] Shawn O’Malley: And the benefits range from how many video meetings people in your company can conduct in a month, the amount of pooled file storage employees have access to, extra security like enhanced malware and phishing protection, and more features like that. And I’m sure this is super sticky. If all of your employees calendars are integrated into Google Calendar and all your internal files are organized on Drive while your emails are hosted through Gmail, then you’re not likely to just suddenly switch all that over even if Google were to fairly dramatically raise prices.

[00:16:20] Shawn O’Malley: These services are so valuable and yet so cheap, I’m sure Alphabet could raise prices considerably before seeing much churn. And then when it comes to Google Maps, this is another powerful business where, at first, it seems too good to be true. We kind of take it for granted now, but when you think about how amazing it is to be able to route yourself anywhere in the world for free, whether it be by car, foot, train, or bike, that is super powerful.

[00:16:43] Shawn O’Malley: But again, it wasn’t clear to me, as someone who has always used maps and taken it for granted, how Alphabet was giving away this useful service for seemingly free. Of course, that’s not exactly what they’re doing. Local businesses can actually pay to have their stores more prominently marked on maps with promoted pins and search results in the app, and Alphabet collects fees by allowing other services to integrate with maps.

[00:17:07] Shawn O’Malley: So that could be any other application that has some directional functionality, whether that’s a food delivery service or a ride sharing app, and they might pay a usage based fee to Alphabet to use its maps data. With Google Photos, Alphabet has migrated from giving folks unlimited free storage to now counting photos against the 15 gigabytes of free storage they offer across Photos, Drive, and Gmail.

[00:17:29] Shawn O’Malley: But the paid plans for more storage are very cheap, like 2 per month for an additional 100 gigabytes. And again, this is just brilliant from a business perspective. By pulling people into their ecosystem for years by giving away so much for free, people might have their entire life’s photos stored in Google.

[00:17:45] Shawn O’Malley: So of course, you’re probably just going to pay 2 per month for more storage rather than trying to offload them somewhere else, which could easily end up being more expensive and just more difficult to do. Even with Google Earth, that’s a service I remember mindlessly messing around on in school for free as a kid, and unsurprisingly, there’s a whole commercial element to it where Alphabet licenses its geospatial data.

[00:18:07] Shawn O’Malley: So even if it feels like so much of Alphabet’s ecosystem is available for free, there are all sorts of licensing and advertising fees being generated behind the scenes on top of paid subscription options. I’d also say throughout the entire ecosystem, that’s where Alphabet’s AI model Gemini really comes into the picture because it’s meant to streamline tools, provide feedback and suggestions and really just improve the experience and productivity all around throughout Google’s suite of products.

[00:18:33] Shawn O’Malley: As a company, Alphabet has come such a long way. Google was founded in September of 1998. Born out of a research project two years earlier by Larry Page and Sergey Brin, while both were PhD students at Stanford. It was actually a third man, though, named Scott Hassan, who is often referred to as the company’s unofficial third founder, since he wrote much of the original code, powering Google’s search engine, but left before Google became an official company.

[00:18:58] Shawn O’Malley: Whereas search engines at the time ranked results simply by counting how many times the search for terms were mentioned on a page, Google’s founders imagined a better system that analyzed the relationships between websites, which they called PageRank. PageRank determined a website’s relevance to a search based on the number of quality links to a page from other websites, using the assumption that the most important websites would receive the most and highest quality links from other websites.

[00:19:24] Shawn O’Malley: Correspondingly, they initially nicknamed the new search engine Backrub because of how it relied so heavily on backlinks to estimate the importance of a given website. Of course, they later changed the name from Backrub to Google, which was actually an intentional misspelling of the word Google, spelled G O O G O L.

[00:19:43] Shawn O’Malley: A Google is an unimaginably large number equivalent to 10 to the power of 100, meant to convey the massive amount of information the search engine could provide. A googol is actually so large that it’s greater than the number of hydrogen atoms in the observable universe. Or put differently, it would take more than 1, 000 universes filled with grains of sand to equal the number of grains of sand in a googol.

[00:20:08] Shawn O’Malley: That’s not really relevant at all, but the more you know, right? With 100, 000 investment from Andy Bechtolsheim of Sun Microsystems, as well as an angel investment from none other than Jeff Bezos, Google was off and running in 1998, and by 1999 it had caught the attention of major venture capital firms like Kleiner Perkins and Sequoia Capital.

[00:20:28] Shawn O’Malley: And by 2000, Google began monetizing its service by selling advertisements associated with certain search keywords, despite Page and Bren actually initially resisting the idea of a search engine funded by advertising. They did agree though that to prevent the search page from getting cluttered, advertisements needed to be completely text based.

[00:20:46] Shawn O’Malley: In that same year, Google became the default search engine provider for Yahoo, which was one of the most popular websites in the world at the time. Already in 2003, the word Google had made its way into everyday language, prompting both the Merriam Webster and Oxford dictionaries to include Google as a new word.

[00:21:03] Shawn O’Malley: Google IPO’d on August 19, 2004, with a market capitalization of over 23 billion and listed its stock under the ticker GOOG. This listing was later split into two share classes, Class A and Class C, with the main difference being that Class A shareholders have voting rights. Well, class C shareholders don’t.

[00:21:24] Shawn O’Malley: In effect, this was a way for the company’s founders to retain voting power over Alphabet, even as their economic stake is diluted over time as the company’s share count expands. Larry Page and Sergey Brin actually have a third type of share class, known as class B shares, that cannot trade publicly but have 10 times the voting power as class A shares.

[00:21:43] Shawn O’Malley: This is a peculiar dynamic, and I find it concerning in some ways. Concentrating power over the company in two people’s hands is clearly unfair to other shareholders. And yet, when you have the track record of success that Alphabet has, you can easily get away with this kind of structure. Having Page and Brin involved with Alphabet provides reassurance in some ways that its founding visionaries are still steering the ship.

[00:22:05] Shawn O’Malley: But for all they’ve accomplished, they’re not infallible either, especially now that they’re older and already very rich, which could distort how they see the world or reduce their motivation. I see this as a mixed bag that is probably not ideal for all other shareholders, and that is in a way, though, just the price you might have to pay to own a business as expansive and powerful as Alphabet.

[00:22:26] Shawn O’Malley: Governance over the company is not fairly distributed yet. That would have been a poor reason to miss out on owning one of the highest quality companies to ever exist. Setting aside governance concerns while the company has had plenty of organic growth since its IPO, they haven’t shied away from acquisitions either.

[00:22:43] Shawn O’Malley: In late 2006, Google acquired YouTube for 1. 65 billion, paid for in shares of its own stock. In other words, Google issued new shares of stock to shareholders and YouTube in exchange for control of the company. It also acquired a firm called DoubleClick for 3. 1 billion in 2008, which helped the company further build its advertising business through DoubleClick’s relationships with web publishers and advertising agencies.

[00:23:09] Shawn O’Malley: And in 2013, Google acquired the navigational app Waze for around 966 million, which remains popular to this day for its crowdsourced updates on traffic, police, accidents, and more. In 2014, Google also acquired DeepMind Technologies, helping to cement the company’s focus on AI over a decade ago.

[00:23:29] Shawn O’Malley: DeepMind’s AlphaGo made headlines shortly thereafter for building the first AI system to beat professional human players of the Chinese board game Go. And then that brings us back to 2015 when Google changed its name to Alphabet to reflect its conglomerate status as a holding company for a diverse range of businesses.

[00:23:47] Shawn O’Malley: Clearly, I’m skipping over a lot along the way here. I’m just hitting some of the biggest headlines for the company over the years to paint a picture of where it’s been and how that has shaped what it is today. More recently, in early 2023, there was a lot of media coverage over Alphabet’s senior management issuing a code red directive for the company’s most important products to all incorporate generative AI within a few months in response to the launch of ChatGPT.

[00:24:14] Shawn O’Malley: It wouldn’t be productive for me to sit here and try to muse about where Alphabet stands in the AI race, since I think there’s probably a pretty small subset of people in Silicon Valley who are actually qualified to comment on that, and I’m not one of them, but there is a real head to head battle going on here with the big tech firms.

[00:24:30] Shawn O’Malley: Microsoft has tied itself to OpenAI and ChatGPT directly, while Amazon is investing hundreds of millions of dollars into Perplexity. Alphabet, instead, seems to be wagering more on its own technology through Gemini. I also think it’s important not to speak about AI as a monolith, when we refer to it as a race, we should also define the parameters of that race, as in who is even competing in the race, how many races are being run, and where is the race going.

[00:24:57] Shawn O’Malley: That is to say, what Apple and Amazon, for example, are hoping to accomplish with AI technology could be meaningfully different. Instead of thinking of AI as a race to build an all-powerful super intelligence, which for the record, some people are definitely trying to do, I think more realistically, all these companies are racing to figure out how to use AI to scale and augment their existing businesses.

[00:25:19] Shawn O’Malley: And naturally, the use cases for AI work very widely for each company. I could certainly be convinced that OpenAI, Perplexity, and Anthropic will all disrupt the information search business, and conversely, I could easily believe as well that Alphabet’s Gemini will help nerf any of this lost market share, as it becomes clear that most people are happy to just use Google search, and chatbots aren’t enough of an improvement to drive a major behavioral change in people’s habits.

[00:25:44] Shawn O’Malley: From my personal experience, there are definitely certain types of questions that I go to chatbots for, but they’re almost new types of questions that I wouldn’t otherwise ask, because I know they’re too nuanced or niche for a search engine to be able to help with. Maybe you see that as an argument against Google search engines, but I see it more as a nuanced but slightly different use case for chatbots, as I still continue to probably use Google search as much as ever.

[00:26:09] Shawn O’Malley: ChatGPT helps me proofread and rewrite things, define jargon, brainstorm ideas, and even review my Excel spreadsheets. But for the most part, these were never things I’d use Google search for anyways, besides maybe the defining jargon aspect. And even with that, definitions of esoteric finance terms is probably not a very monetizable search that Alphabet makes a lot of money on.

[00:26:30] Shawn O’Malley: If you’d asked me six months ago, I probably would have said chatbots were going to destroy search. But today I realize that for many of the most valuable aspects of search, I’m still reliant on Google. If I want to know the hours that my favorite taco place is open, I’m going to Google that, not ask ChatGPT.

[00:26:47] Shawn O’Malley: If I’m looking for massage therapists in the area, I’m probably going to do a Google search. Maybe that will change for me over time, but at least anecdotally, I go to ChatGPT with more novel types of questions that I’m not convinced are valuable from an advertising perspective. I could see, though, how AI summaries will make many webpages irrelevant.

[00:27:05] Shawn O’Malley: If a website used to be devoted to publishing information that is now easily displayed at the top of search results in a two paragraph summary, then many website publishers might just stop maintaining their sites since they might feel like they’ve become redundant. That could be detrimental to the quality of search engines over time, and the foundation of Google’s search business.

[00:27:23] Shawn O’Malley: So don’t get me wrong, I do think how we consume information is quickly changing, but I’m also not as bearish on Google as I was during all the initial hype about AI models. Alphabet is using AI to enhance and better sort search results. So there’s a case where AI actually makes online search better.

[00:27:40] Shawn O’Malley: Based on the context of your search, it may decide whether to first show you recipes, news articles, videos, maps, or a blend of these different types of results, as opposed to just a list of websites. And then I don’t know if you’ve ever used Google Lens, but that is a pretty incredible product too. It literally brings search into the real world for things that words just can’t describe.

[00:27:59] Shawn O’Malley: If you see a plant that you want to know the name of, just open Google Lens and it’ll tell you, instead of trying to describe the plant in written search. Or if you’re having issues with a record player for your music, you could open Google Lens, show a video of what’s going on to their AI, and it can tell you how to fix your record player, which just objectively is very, very cool technology.

[00:28:20] Shawn O’Malley: There are other considerations to be had, for sure, though, with AI in Search. For example, AI responses require much more computing power than Google Search, so it can be as much as seven times more expensive to generate an AI answer than to just Google something. And as Alphabet uses more and more AI summaries and responses to compete with ChatGPT, that will probably hurt the Search business’s margins.

[00:28:43] Shawn O’Malley: Every 10 percent of Google searches that shift to generative AI could increase Alphabet’s operating costs by hundreds of millions or even billions of dollars. That said, generative AI is a new technology, and as scale and improved efficiencies come into play over time, it may prove to be much less comparatively expensive to have Gemini provide an AI summary to your question than it currently is.

[00:29:04] Shawn O’Malley: There are already some speculative headlines out there suggesting companies like Alphabet have found ways to dramatically scale down their costs related to large language models. And to hedge the costs of AI, Alphabet has been both stocking up on NVIDIA’s computer chips as well as using chips that the company has designed itself where they can better control costs.

[00:29:23] Shawn O’Malley: So we’ve talked about the backstory for Alphabet, acquisitions the company has made, how it monetizes free services and AI, but let’s flesh out the company’s business model a bit further. It’s important to understand that over two thirds of Alphabet’s revenues come from advertising, and those revenues come from search mostly, but also YouTube and AdSense, Alphabet’s advertising network that connects websites with eyeballs to advertisers who want those eyeballs on their products.

[00:29:48] Shawn O’Malley: With Alphabet’s search business already generating hundreds of billions of dollars of revenue per year, you might think it can’t grow that much further. I would have thought that too, but I was surprised to learn that 80 percent of searches on Google do not have any ads. So clearly there’s a lot of room to expand the number of ad placements on Google.

[00:30:06] Shawn O’Malley: And so with search and advertising being such a key pillar of Alphabet’s business, naturally we’d want to look at some metrics besides revenues to see on a fundamental level how healthy this business is. Since 2019, the number of views on pages from Google search grew about 9 percent per year to over 7. 1 trillion. Well, click through rates for ads rose from 4.8% to 5.9%, meaning ads were more relevant and more effective as a higher percentage of people clicked on the ads that were shown to them. So structurally, there are more views on search results. And a higher percentage of people clicking on ads in search results too, which are both good news for Alphabet and a testament to their skill in delivering relevant search results and ads in a balanced way.

[00:30:48] Shawn O’Malley: Correspondingly, the number of clicks paid for by advertisers nearly doubled from 2019 through 2023. Despite all the hype about threats from AI chatbots, the ad supported search business is not just alive and well, but rapidly growing. For context, some of the numbers I’m using here have come from a presentation I tuned into with Manish Koira.

[00:31:07] Shawn O’Malley: Who is a really talented investor who does research and portfolio management for the firm pragmatic investments. He believes that Alphabet’s other advertising pillar, YouTube, is also doing quite well, which is probably not surprising to anyone to hear. Carrera estimates that the number of views on YouTube rose from 9 trillion in 2019 to 19 trillion in 2023, while the number of impressions for ads also doubled in 4 years.

[00:31:33] Shawn O’Malley: Meanwhile, the number of subscribers to YouTube music, a competitor with Spotify, has likely grown from 20 million to around 90 million, and the price per user has gone up from 7 per month to 9. The similar story with YouTube TV, the number of subscribers has more than tripled since 2019, while the price per paid user has grown from 45 on average to 73.

[00:31:57] Shawn O’Malley: So in terms of engagement, eyeballs, advertising, music, and TV subscriptions, YouTube is churning away on all fronts. Most people know how good of a business search has been for Google, but YouTube was more of a hidden gem for a while, and now I’m just so blown away with what they’ve been able to do with it.

[00:32:14] Shawn O’Malley: I grew up using YouTube, so intuitively, I get why it’s a great product, yet I didn’t see the expansions into TV and paid music coming either, though. Netflix or Disney when we talk about streaming, YouTube is undoubtedly the largest video streaming platform in the world. It goes without saying that there’s just a functionally infinite amount of incredible content on YouTube, and honestly, I don’t really know how other streaming platforms can even compete.

[00:32:38] Shawn O’Malley: There will always be a place for Game of Thrones and HBO subscriptions, but what I love about YouTube is that there are so many reasons to engage with it. Whether you’re looking for a tutorial to fix your car, have questions on which type of makeup to use, want to watch a trailer for a new movie, follow your favorite video game streamer or want to see news coverage of local elections, all that and obviously so much more can be found there.

[00:33:00] Shawn O’Malley: For work or leisure, elderly or youth, in any language, YouTube has it all and appeals to everyone. I can hardly think of anyone that I’ve ever met who doesn’t at least periodically use YouTube, even if they didn’t intentionally seek it out. YouTube videos are embedded into websites and social media, and of course, Google’s search engine is a powerful tool driving the flywheel here and directing people to relevant videos for their searches.

[00:33:23] Shawn O’Malley: Unlike Netflix, which has fixed content costs and pays for the rights to shows or produces its own shows, YouTube’s costs are variable. They increase with rising total views and decrease with falling total views. If everyone stopped watching YouTube, it wouldn’t be stuck with the rights and production costs for 200 TV shows like Netflix.

[00:33:42] Shawn O’Malley: There were no views, YouTube would owe content creators nothing. And Netflix has to pay for all of its own marketing. If they want more eyeballs on a new show, they might actually pay Alphabet to have a show promoted across YouTube in search. Alphabet doesn’t need to advertise YouTube, though, because YouTube content creators do it for them.

[00:34:00] Shawn O’Malley: I know that from firsthand experience. Quite literally, I produce content that goes on YouTube and generates ad revenue for Alphabet, and then I go out and try to get as many people as possible to watch it for this podcast and then multiply that by thousands of creators. Podcasts like this one are effectively doing the marketing costs for YouTube, which if you didn’t know, it’s a good time to mention that you can watch this podcast on YouTube and see the charts I’ve been referencing throughout.

[00:34:25] Shawn O’Malley: So there you go. There’s my promotional spiel supporting YouTube, but that is really how it works. Creators do all the marketing for YouTube on their Tik TOKs, Facebook accounts, Reddit, newsletters, wherever it is, they’re publishing on YouTube and have followings elsewhere. They’re probably directing at least a portion of their audience to consume that YouTube content.

[00:34:43] Shawn O’Malley: This is an understated advantage for YouTube versus other video content platforms in my opinion and is a great illustration of how the decentralized nature of YouTube is what makes it so compelling. Rather than some big corporation trying to sell you on watching another superhero movie in theaters or through streaming, it’s millions of individuals and smaller production companies trying to craft content that’s relevant to the exact niche that you’re interested in.

[00:35:06] Shawn O’Malley: Possibly as impressive as YouTube is Alphabet’s a fast growing cloud computing business. This is a unit where 30 percent growth is a slow year and one that’s trending toward profitability after years of being unprofitable as growth exploded. This is a market where it’s not exactly easy for new competitors to enter given the massive scale of investments that are needed.

[00:35:26] Shawn O’Malley: The cloud industry is very much being divided up by Amazon, Microsoft, and Alphabet. In case you’re wondering what, I mean when I say cloud, since it’s a word that gets thrown around a lot but isn’t always defined, let me just say that put simply, Google Cloud enables people and businesses to use Google’s powerful computers, storage, and tools over the internet.

[00:35:45] Shawn O’Malley: Instead of buying their own servers, people can use Google’s servers to run apps, store data, and analyze information. So it’s like renting Google’s tech to build and grow your own projects. You’re sort of outsourcing your computer power and storage to Google, which has massive data centers and supercomputers for customers to tap into.

[00:36:03] Shawn O’Malley: When it comes to costs, there’s all the usual corporate stuff you’d think of offices, salaries for software programmers, computers, 401k and healthcare, all that sort of stuff. More unique to Alphabet though, are what it calls its traffic acquisition costs, which they often abbreviate in financial filings as just TAC.

[00:36:22] Shawn O’Malley: For example, for the search engine business, Alphabet pays Apple billions of dollars a year amounting to about 36 percent of its ad revenues for searches in Apple’s Safari browser. In return, Apple continues to set Google as the default search engine across tens of millions of devices. On YouTube, the acquisition cost is effectively what Alphabet must pay content creators so there’s an economic incentive for them to keep publishing their content on YouTube.

[00:36:47] Shawn O’Malley: In fact, about 55 percent of YouTube’s revenues go to content creators. And then there are fixed costs tied to data centers, customer support systems, production costs, or pixel devices, and these all factor into Alphabet’s cost structure too. So, we’ve gone over these sources of revenues and costs. Now, let’s look at some of the metrics that are more directly relevant to the returns earned by shareholders.

[00:37:09] Shawn O’Malley: In 2023, Alphabet generated nearly 70 billion in free cash flow, of which it spent around 62 billion on repurchasing its own stock. Obviously, this is just a massive amount, and from Q1 2021 through Q1 2024, Alphabet reduced its total share count by 8. 5 percent in total, or nearly 3 percent per year.

[00:37:30] Shawn O’Malley: Alphabet tends to be on the more aggressive side of using share based compensation to pay its employees and retain top talent at the company, but it more than makes up for that with buybacks. Share buybacks can be a wonderful thing because they take the extra cash flow that’s not needed for growing or maintaining the business and put that towards shrinking the number of shares available, which actually makes shares of the stock more scarce and increase ongoing shareholders ownership slice in the company.

[00:37:56] Shawn O’Malley: If you own 100 shares in a company with 1000 shares outstanding, and the company buys back 200 shares, now you own 1 8th of the business going forward as opposed to owning just 1 10th of it. And the price for that increased ownership is the cash that was sucked out of the business to purchase those shares from shareholders who wanted to sell out of their position.

[00:38:14] Shawn O’Malley: For a company that’s not nearly as profitable as Alphabet, buybacks could be less of a good thing if they come at the cost of sapping up cash that could have been used toward compelling growth initiatives that boosted future returns. In that case, you’d be sacrificing future growth for a larger ownership stake in a company that was worth less since it had less cash and wouldn’t be growing as fast as it could.

[00:38:35] Shawn O’Malley: So there is a real trade off being made in theory, but with Alphabet, I really don’t think that’s the case at all. Alphabet is so ridiculously big and profitable that the company can spend a pretty small percentage of its revenue on R& D and innovative new products, but And still be spending tens of billions of dollars more on growing and maintaining its businesses than just about any other company out there besides the other big tech giants.

[00:38:56] Shawn O’Malley: The point being Alphabet generates enough nominal profits that it can reinvest in maintaining its current competitive advantages, invest in speculative businesses on the cutting edge of technology like Waymo, and have an objectively massive sum of cash left over to return to shareholders in the form of buyback still.

[00:39:13] Shawn O’Malley: Which, as I’ve said, increases their ownership slice of a growing pie. Alphabet has the high class problem of not knowing what to do with all the cash it has. We’re talking about almost a hundred billion dollars of cash on its balance sheet, so that is a real fortress balance sheet if I’ve ever seen one.

[00:39:29] Shawn O’Malley: If they can’t find enough attractive things to invest in, then they will continue to just pay out big chunks of that cash as dividends or share repurchases. So I have in my notes here to cover the regulatory environment around Alphabet, and that is pretty daunting. It’s way above my pay grade to assess the legal questions surrounding Alphabet or go into the litany of cases against the company.

[00:39:50] Shawn O’Malley: Antitrust and legal enforcement against a tech company like Alphabet will naturally vary by country, as in Australia may respond differently than the EU, which responds differently than the US. And while these get a lot of headlines, some simple common sense tells us that these developments mostly tend to be inconsequential for investors.

[00:40:08] Shawn O’Malley: In August 2024, a federal judge in the U. S. ruled that Google had unlawfully maintained monopolies in online search and search advertising markets, and it remains unclear what, if anything, would be done to address these monopolistic practices. It’s possible that the Department of Justice could force Alphabet to spin off ownership of its Chrome browsers or force it to stop paying companies like Apple to make Google their default search engine.

[00:40:32] Shawn O’Malley: Again, you can imagine a million different things that could happen, but at the end of the day, a lot of it is, in a way, political. Regulators want to look as though they’re taking action, and yet there probably isn’t a huge appetite to disrupt a fundamental set of services that millions of their citizens rely on and are, for the most part, fairly happy with.

[00:40:50] Shawn O’Malley: It’s certainly not uncommon for regulators to impose multi-billion dollar fines on Alphabet, which the EU did as recently as September 2024, but in a way, this is almost like a cost of doing business for them. A 2. 5 billion dollar fine is a rounding error, and I’m sure Alphabet would much rather pay those fines than actually change how they operate.

[00:41:08] Shawn O’Malley: Alphabet and other big tech giants are not these simple toll road monopolies of the 20th century that we learned about in econ textbooks that make society objectively worse off. Alphabet is an extremely innovative company that has, in my opinion, contributed very positively on net to the world. That’s not a wholesale endorsement of everything Alphabet has ever done, but their services have definitely made my life better, and if the price of that is seeing ads on YouTube or on my searches, I’m pretty much fine with that.

[00:41:35] Shawn O’Malley: I know I’m massively disregarding very legitimate concerns about anti-competitive practices that have hurt certain small businesses and startups, but still, at a society wide level, I think we’re all immensely better off for services like Google Search. Gmail and Google maps existing and also being free for most people.

[00:41:52] Shawn O’Malley: It’s perfectly valid to feel differently though. The focus here is really on how regulatory decisions will impact investors. And if the last 30 years are any guide, regulatory decisions have been pretty muted. The biggest example of antitrust enforcement in the 21st century came in 2001 against Microsoft, and yet, Microsoft is the third most valuable company on the planet today.

[00:42:13] Shawn O’Malley: For all the investigations, court hearings, and ink spilled warning of how Microsoft was behaving anti competitively, none of them has had a lasting impact on the company. It remains as prominent and powerful as ever, if not more so. According to the Wall Street Journal, it’s actually been 40 years since the Department of Justice broke up a company on antitrust grounds with AT&T.

[00:42:34] Shawn O’Malley: They had tried to order the breakup of Microsoft, but a set of federal judges found that the trial judge had engaged in misconduct by being publicly biased in favor of breaking up Microsoft, which ultimately led Microsoft to not be broken up. Judges typically view breakups as an extreme remedy to be avoided because they could have unintended consequences such as creating a new standalone company that promptly fails and hurts consumers.

[00:42:58] Shawn O’Malley: So the point is that we have a tangled and slow moving legal system, and even if there is an obvious case for something to happen, a hangup as simple as a biased judge can derail the entire process. The most tangible effect of all this is that I do think it’s harder for companies like Alphabet to make acquisitions than it used to be because they’re already so big and so any meaningful acquisition immediately raises concerns about competitiveness.

[00:43:22] Shawn O’Malley: That makes it more challenging for Alphabet to deploy all its cash, which is probably why you have seen them lean more into private equity and VC funds as ways to deploy some cash into younger companies rather than directly making acquisitions. If regulators were to have their way, though, there could be real consequences for shareholders, at least according to Thomas Lenard and Scott Walson of the Technology Policy Institute in an opinion piece for the Wall Street Journal.

[00:43:46] Shawn O’Malley: They write, quote, The Justice Department wants to turn America’s most successful search engine into a public utility. As part of its proposed remedies in an antitrust case against Google, the department would force the company to share its technology, data, and models with competitors at marginal cost.

[00:44:03] Shawn O’Malley: This is the same strategy it used against the incumbent telephone companies in the 1990s. It discouraged investment in competition. The strategy would have similarly deleterious effects today, undermining consumer welfare, innovation and U. S. leadership, and artificial intelligence at the worst possible moment.

[00:44:20] Shawn O’Malley: The scope of the requirements is staggering. Google would be required to share its search index, its user data, and the fruits of its research and development with rivals, all without making a real profit. Any company could resell Google’s search results rather than develop its own technology. This regulatory market manipulation is a sharp departure from the consumer welfare standard that is meant to guide antitrust policy.

[00:44:42] Shawn O’Malley: They continue, saying, When the government tried to do the same thing to the phone companies in the 90s, disputes over cost allocation proved endless. Like a single phone call, the cost of a single search query may be close to zero, but the equipment, research and development, and network costs that allow for it are substantial.

[00:44:59] Shawn O’Malley: The Federal Communications Commission spent years adjudicating disputes over cost allocation, producing complex methodologies that were immediately challenged in court. The Justice Department would face similar problems with its proposed Google breakup. This is all well beyond my domain of expertise, which immediately makes me want to put Alphabet in the too hard basket.

[00:45:20] Shawn O’Malley: Perhaps I’m naive, but my default thought is to assume that nothing major will happen, as nothing major has happened for years. Basically, I expect the status quo to continue until I’m proven beyond a doubt that there will be real changes. If you had let regulatory headlines scare you out of alphabet at any point in the last 10 years, you would have missed out on a stock that has compounded at more than 20 percent per year.

[00:45:42] Shawn O’Malley: Pivoting a bit. I want to talk about who all is invested in Alphabet. I don’t solely buy stocks because they’re owned by legendary investors, but it is something I take notice of. And with Alphabet, there’s a pretty incredible roster of investors who continue to hold shares in the company. The usual caveats here are that ownership disclosures come at a delay, looming capital gains taxes can keep investors locked into a stock and holding a position still is not the same as saying they would invest in the company from scratch today at these prices in the same proportion.

[00:46:11] Shawn O’Malley: A prominent investor may continue to hold an investment, even if they wouldn’t buy it at today’s prices simply because they don’t have a more compelling investment opportunity on their radar to put their cash towards. But with these caveats out of the way, I don’t think we can just disregard the fact that an investor as iconic as Lee Liu of Himalaya Capital Management has nearly 40 percent of his concentrated portfolio in the company.

[00:46:32] Shawn O’Malley: And then you’ve got other legends like Bill Ackman with over 15 percent of his portfolio concentrated in Alphabet, as well as Bill Nygren of Oak mark with almost 8 percent of his portfolio in the company. Then there’s Francois Rochon, who has around 11 percent of his portfolio in Alphabet stock.

[00:46:46] Shawn O’Malley: Alongside other greats like Guy Spear, Thomas Gaynor, Terry Smith, Seth Klarman, and David Tepper, who all have substantial positions in Google stock as well. Even if you’re not familiar with some of those names specifically, trust me when I say these are real titans of industry. Li Liu, for example, appears to have the highest conviction in Alphabet based on its weight in his portfolio, and is perhaps best known for his close friendship with Charlie Munger.

[00:47:10] Shawn O’Malley: In fact, Charlie Munger has said that Li Liu is the only outside investment manager he has ever invested with, and even described him as the quote, Chinese Warren Buffett. If you combine Alphabet’s two share classes together, it is easily the largest portfolio holding on Datarama, a great website devoted to tracking the investments of so called super investors.

[00:47:30] Shawn O’Malley: I think you can see this going both ways. On the one hand, clearly a lot of very capable and sophisticated investors have been drawn to invest in Alphabet, and on the other, this also means Alphabet is one of the most closely studied and tracked companies on Earth, if not the most. As such, you’d expect the market for its shares to be relatively more efficient, giving fewer opportunities to buy in beneath intrinsic value.

[00:47:51] Shawn O’Malley: I personally feel conflicted because the commonsense side of my brain says, hey dummy, don’t overthink this. Alphabet is a brilliant company and people much smarter than me are in agreement about that. And yet another part of my gut says that sort of thinking is exactly why the company is not an attractive investment.

[00:48:06] Shawn O’Malley: It’s too well followed with too many momentum chasers following what other investors do, adding to its strong history of returns and drawing in more investors until its valuation no longer reflects reality. Rather than speculating, let’s just go ahead and see whether we can construct our own estimate of intrinsic value for Alphabet.

[00:48:24] Shawn O’Malley: This is a company that being directionally correct about is most important. Rather than trying to estimate the value of a $2 trillion market cap company down to the exact penny, I found there’s an 80 20 rule to valuation. With 20% of the work, you can get 80% of the valuation using some very basic frameworks.

[00:48:39] Shawn O’Malley: They’ll tell you roughly what’s going on. As such, the simpler the model, the better, because as I’ve said in past episodes, I’m not going to go off an exact price target from a model anyway, so there’s no use in getting bogged down by an intricate model when I could use that time reading more deeply about a company and Better understanding the qualitative factors surrounding it.

[00:48:59] Shawn O’Malley: Models use a lot of assumptions, and I just fundamentally reject the idea that we can distill a company with over a hundred thousand employees into a spreadsheet. Models are there to, well, model things and give an approximate idea of what’s happening. And then it’s up to us from there to decide whether we’re comfortable with that approximate valuation, but more importantly, whether we believe its competitive advantages will endure.

[00:49:21] Shawn O’Malley: No model can tell you that, but your qualitative understanding of the business might. So we might just simply break out the key business units for Alphabet by revenue, multiply those revenues by their profit margins for each different unit, and then slap on a multiple, as they say, to each unit and sum everything together to guide our thinking on whether Alphabet is reasonably valued.

[00:49:41] Shawn O’Malley: Whether it’s egregiously under or overvalued. The multiple is the number you multiply profits by to estimate the total value of the company or business unit. The faster a business unit is growing, the higher the multiple you’d want to use. Let me just show you what I mean. Alphabet’s largest division is connected to its search business, which the company refers to as Google search and other, because it also includes revenues tied to services like Gmail and Google maps.

[00:50:07] Shawn O’Malley: The search and other unit has generated $190 billion in revenue in the past 12 months. According to Alphabet’s financial filings. This unit has a roughly 30% profit margin, meaning on $192 billion in revenue. That’s $57 billion in profit in 2024. But Alphabet will probably generate those kinds of earnings for many years to come.

[00:50:28] Shawn O’Malley: So when you think about the value of its search business, I’d say a multiple of 20 is fairly reasonable. That multiple is meant to reflect that search is a growing, but mostly mature business for Alphabet. And if it were to stay completely flat for the next few decades, we’d receive a 5 percent earnings yield per year from the search business.

[00:50:45] Shawn O’Malley: I get that by just dividing 1 over the multiple, which in this case is 20, so 1 divided by 20 is a 5 percent yield, assuming no growth in what is a monopoly business. That’s actually more than the yield you’d earn from a 10 year treasury bond from the US government, and we’re not even accounting for the fact that Alphabet’s profits from search will almost certainly continue to grow, further increasing the earnings yield we receive as investors.

[00:51:09] Shawn O’Malley: In the last five years, this unit has grown revenues by over 17 percent per year, which is very solid. So this is a rough and oversimplified process, but that’s the point. I just want to show how I think about things and what it means, for example, to use a multiple of 20 to value the search business. The multiple of 20, we just multiply 20 by the search business’s 57 billion dollars in profit to estimate its value at more than 1.1 trillion dollars.

[00:51:34] Shawn O’Malley: We used a higher multiple, we’d be accepting a lower earnings yield today and banking on future growth to deliver a more attractive yield, but the estimated value of the search business would increase too. With a higher multiple of 30, you’re receiving just a 3.3 percent earnings yield today, which would get dividing one by 30.

[00:51:51] Shawn O’Malley: But the estimate of these search businesses value jumps to 1.7 trillion. So that’s what I mean by saying with a higher multiple, we’re implicitly betting more on future growth. Otherwise we’re accepting a 3.3 percent yield when we could get a much higher yield by simply buying risk free government bonds.

[00:52:08] Shawn O’Malley: And I’m more comfortable, as I said, with using a multiple of 20 to value the search business, as that implies a modest 5 percent yield today and generates a more conservative valuation of 1. 1 trillion. Next, we’d want to try and estimate the value of YouTube and then add that onto the 1. 1 trillion of intrinsic value we have already calculated.

[00:52:28] Shawn O’Malley: YouTube’s ad business has actually grown even faster than its search business at more than 23 percent per year for the last five years, so we could probably justify a modestly higher multiple on the business thanks to that stronger growth. Same as we did before, I’ll multiply the 35 billion of revenue that Alphabet has generated from advertising on YouTube by a 30 percent margin to get the estimated profits.

[00:52:50] Shawn O’Malley: And then multiply that number by a multiple of 30, which comes out to an estimated valuation of over 300 billion for YouTube, not even accounting for YouTube TV or YouTube premium subscriptions. So with the search business and YouTube’s advertising revenues, we’re already at about 1.4 trillion of estimated value.

[00:53:08] Shawn O’Malley: We still have a few other divisions to get to. I’m throwing around a bunch of numbers and I don’t want this to get too technical since it can be hard to follow in a podcast format. So I would encourage you to check out our intrinsic value newsletter, which I’ll link to in the show notes there. You can clearly see the numbers I’m working with and the model that I built out.

[00:53:25] Shawn O’Malley: In short, though, you’d go through a similar process of breaking out Alphabet’s different business divisions and revenues, estimating their profit margins, and multiplying the profits by a multiple based on how optimistic you are about that unit’s growth. For example, there’s one more part of Alphabet’s advertising business called Google Network, which includes AdSense.

[00:53:43] Shawn O’Malley: I mentioned this earlier, but again, AdSense is a service that websites can tap into to easily earn money from advertisements on their pages. If you have a website that gets, say, a few thousand viewers each week, you could opt into AdSense and pay Alphabet a percentage of your revenues as compensation for them helping you easily source advertisers rather than having to try and do that yourself.

[00:54:02] Shawn O’Malley: Growth in AdSense and related businesses has stagnated for a few reasons, but one big factor is that people increasingly spend most of their time in a few social media ecosystems like Facebook, TikTok, or Reddit, where they get much of their news and entertainment and thus spend less time on the open web visiting more traditional websites.

[00:54:20] Shawn O’Malley: And of course, less traffic to other types of websites means less ad dollars for these publishers as well as for Alphabet. The reality that many publishers are confronting is that advertising is simply not as viable of a business model as it once was, driving many to turn to subscription models that rely less on advertising marketplaces like AdSense.

[00:54:39] Shawn O’Malley: So to value AdSense and the Google network more broadly as it’s known, I’d probably want to use a lower multiple to account for that flattening growth, as well as a lower profit margin since the acquisition costs for this unit tend to be higher. That is to say, there are apparently higher costs associated with paying website publishers for the traffic they generate for advertisers, compared with the payouts made to content creators on YouTube for the views they generate, at least according to Alphabet’s own financial statements.

[00:55:05] Shawn O’Malley: The Google network is also less profitable comparatively due to the large payouts it makes to so called distributors like Apple, who it pays to keep Google as the default search engine for Safari. All in all, I use a more conservative multiple of 15 and lower 20 percent profit margin to estimate that the Google network is worth about 90 billion.

[00:55:24] Shawn O’Malley: We also can’t forget about Alphabet’s Cloud business, which generates about $45 billion in annual revenue. The cloud computing business has grown just massively jumping almost 40% a year for the past five years from $9 billion in 2019. As a result, we’d want to use a much higher multiple for this division and using Amazon Web Services profit margins as a peer to compare against.

[00:55:46] Shawn O’Malley: I feel comfortable with estimating the cloud division’s margins at around 25%. With a multiple of 35, I get a valuation for the cloud division of roughly 400 billion. Adding that to the valuation for the other business units, we’re at approximately 1. 9 trillion dollars in estimated value for Alphabet so far, for anyone who’s keeping score at home.

[00:56:06] Shawn O’Malley: We are very much not done yet, though. We still have only accounted for the value of YouTube’s advertising business, not the value of its subscriptions, as well as Android devices and app store Google Play. Financial filings, Alphabet refers to this as Google subscriptions, platforms, and its devices division, and in the last 12 months, it has generated about 39 billion dollars in revenue.

[00:56:27] Shawn O’Malley: That’s up 18 percent per year in the last five years. And if we again assume a 30 percent profit margin in line with the average profit margin Alphabet earns across all of its businesses, I get an estimated valuation for this business of over 230 billion with a multiple of 20. We also don’t want to forget about Waymo, which was recently valued in a fundraise at almost 50 billion.

[00:56:49] Shawn O’Malley: That’s actually down considerably from the 200 billion valuation it was once estimated that. And as we covered at length earlier, Alphabet has its tentacles wrapped around so many in house emerging technologies and innovations they’re investing in through their venture capital and private equity funds, from drone delivery services to biotech research promised around slowing the effects of aging and even SpaceX.

[00:57:10] Shawn O’Malley: Alphabet actually first invested in Elon Musk’s SpaceX in 2015, and they still hold a nearly 8 percent stake in the company that’s estimated to be worth around 12. 5 billion. These other bets do generate over a billion dollars of revenue per year, yet on net, they probably do not generate any profits, since they’re so speculative.

[00:57:29] Shawn O’Malley: That doesn’t mean they’re not worth anything either, though. To write off the optionality that this division offers is to disregard the successes it’s already had, as we’ve seen with Waymo. There’s no good way to value all this speculative technology that Alphabet incubates, and that’s why I appreciate Manish Pabrai’s approach to it.

[00:57:46] Shawn O’Malley: Pabrai is a legend investor in his own right who has invested in Alphabet previously, and said that, and I’m paraphrasing here, he essentially was slightly more generous with his valuation assumptions for Alphabet’s other business models as a result of the other bets division, rather than trying to explicitly value it.

[00:58:03] Shawn O’Malley: And I really appreciate that because I think it’s pragmatic. Alphabet is a company that, at every level, is focused on finding disruptive innovations, and correspondingly, we should probably be more generous when valuing the company and considering its ability to grow, even if many of those side projects aren’t necessarily profitable today.

[00:58:22] Shawn O’Malley: So I took that to heart a bit with the multiples and assumptions I already used for these other divisions, and when I add in the valuation for Waymo, as well as the 60 billion in net cash the company has after subtracting out its debts, I can easily get to a 2. 2 trillion valuation, or 185 per share.

[00:58:38] Shawn O’Malley: That is a modest discount to where the stock has traded recently at north of 200 per share, though it has come down in the past week a bit in response to the Deep Seek Chinese AI technology breakthrough and how they apparently have created a model that rivals ChatGPT at a fraction of the cost. Raising concerns about the supremacy of American innovation and technology, and that has obviously rippled back to affect Alphabet and its perception of being a market leader in AI.

[00:59:10] Shawn O’Malley: Like I’ve already said, this is clearly not an exact science, but this was a helpful exercise just to orient myself. I haven’t even accounted for the fact that software companies like Alphabet invest billions of dollars in R&D aimed toward improving their technology, and yet, most of those costs get expensed immediately, which artificially reduces the accounting for net income and doesn’t reflect the fact that if Alphabet develops a new technology or piece of software, that they could be more lasting assets supporting the business.

[00:59:37] Shawn O’Malley: Adjusting the accounting to reflect that much of Alphabet’s R& D should be depreciated over longer periods rather than expensed up front is a messy process, but it is something that I keep in the back of my head as I think about how attractive an investment in Alphabet is. In a recent video, the Dean evaluation, as he’s known Aswath de Moin, discusses Mag seven companies and adjusts alphabet’s current operating profit margin to account for r and d investments, rather than being immediately ridden off.

[01:00:03] Shawn O’Malley: And his r and d adjusted margin estimate is four percentage points higher at 32%, which is a very material difference. That would be a considerable improvement in how your account for the company’s operating profitability that could be used to justify an even higher valuation for the company. Altogether, I do not feel strongly that Alphabet is hugely undervalued, but it’s not a company I would want to miss out on owning either, which I know is sort of contradictory.

[01:00:28] Shawn O’Malley: It is not expensive with the sorts of rich valuations that other Mag 7 companies have, and in a way that makes it very attractive, because you would expect such a high quality company with so much potential baked into their future, given all of the disruptive technologies that they’re investing in, to be very, very expensive.

[01:00:45] Shawn O’Malley: On a price to earnings basis, half a bit stock is trading at a relatively low level compared to its valuations in the past. Though it’s not as cheap when you look at its valuation in terms of its price to sales ratio and price to free cash flow per share. I really wish I had studied the company sooner so I could have jumped on the opportunity to buy Alphabet’s shares when they were more heavily discounted back in late 2022 and early 2023 when fears of an economic slowdown and the rise of ChatGPT were dominant narratives in the market.

[01:01:12] Shawn O’Malley: Between 180 and 190 per share, I feel like Alphabet is fairly valued. That said, Alphabet is a company I want to own. I do not want to miss out on the economic benefits of their vast array of technologies and assets, and I don’t think it takes much creativity to imagine a bunch of different scenarios where they can keep growing and growing, perhaps growing even faster than some of the outlines I’ve presented today.

[01:01:34] Shawn O’Malley: Unlike other companies I’ve looked at where I’m more inclined to just set them aside in my too hard pile, I feel differently with Alphabet. This is a company I’ve literally grown up with, and that gives me comfort in feeling that I know what they’re all about. They also just have so many compelling technologies that they’re incubating that offer a ton of upside to investors beyond the existing high quality businesses that we’ve already covered in depth to technologies that are more promising that we haven’t really had the chance to cover.

[01:01:59] Shawn O’Malley: As I’ve gotten to learn more about Alphabet’s finances and underlying business, I can’t help myself but want to own it. And so I’m going to be watching its shares very carefully for opportunities to buy in. Mr. Market will almost certainly give me a chance to build a position in the company at more attractive prices, so I very much intend to add Alphabet to the portfolio slowly over time, accumulating shares anytime the price dips below 170, which gives me a bit of buffer room between my already fairly conservative intrinsic value estimate of 185 per share.

[01:02:30] Shawn O’Malley: At the time of recording, Alphabet is, like I said, above that 170 target, so I’m not going to go out and buy it tomorrow, probably, but I will be waiting for the next set of headlines to emerge that spook investors and give me a chance to initiate a position in the company for our intrinsic value portfolio.

[01:02:46] Shawn O’Malley: I’m aiming for a 3 to 5 percent position in the company by the end of the year, but if there’s an even bigger sell off, I could imagine having a position as large as 10%. That would be very concentrated, but we shall see. I’ll keep you all updated in the podcast here and in the intrinsic value newsletter over the coming months on how things go.

[01:03:04] Shawn O’Malley: It has been a long episode and I feel as though I’ve covered everything and yet nothing with Alphabet. There is just so much deeper we could go with anything we’ve touched on today. And I know personally, I still have a lot to learn about the company. I feel good enough generally about its businesses who commit to building a position over time, and in part, having a little skin in the game with 3 or 4 percent of my portfolio is a great motivator to continue tracking Alphabet closely and learning about what they do.

[01:03:29] Shawn O’Malley: I’m an imperfect investor though, biased like we all are by social proof and confirmation biases and many other psychological factors that probably make me more inclined to like Alphabet or want to justify why I shouldn’t miss out on owning it. I’ll be the first to admit there’s no shortage of things I don’t understand about this investment, because, after all, we are talking about a 2 trillion dollar company.

[01:03:50] Shawn O’Malley: Anyone thinks they understand every aspect of Alphabet’s business, and unless they’re the CEO, then I think they’re being disingenuous. You might then think that would be a good reason to put Alphabet in the too hard pile, and perhaps you’re right. But with that, I’ll just say that I hope to see you in Omaha this year for the Berkshire Hathaway shareholder meeting, and we can chat further about it in person.

[01:04:11] Shawn O’Malley: I know a ton of listeners are already going, and if you don’t have your trip planned, I’d strongly recommend you look into it. We are hosting two nights of free events at the Blatt Beer and Table, spelled B L A T T, on Friday and Saturday night from 6 to 9 p.m. The Blatt is a bar downtown, and we’ll be having free foods and drinks for anyone who can make it.

[01:04:30] Shawn O’Malley: If you really disagree with my thinking on Alphabet here, I’d love to hear why from you in person, like I already said. Before I go, I’ll leave you with a quote from Alphabet’s co-founder, Sergey Brin. He says, If what we are doing is not seen by some people as science fiction, it’s probably not transformative enough. I’ll be back again next week, breaking down another interesting business and looking for more additions to our Intrinsic Value Portfolio. See you then.

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