Brisk Revenue Growth, Improving Margins Helped Google’s Stock Double In 5 Years

Alphabet (NASDAQ:GOOG) recently disclosed that its cloud business now has a run rate of $8 billion a year. The company has done extremely well to double its cloud revenues from the billion-dollar-a-quarter level in Q4 2017. In addition to growth in cloud, the company appears to be firing on all cylinders of late – helping its share price trend higher after a notable dip in price at the beginning of the year and again in June. Taking into account the recent rally, Google’s valuation has increased almost 100% over the last 5 years.

The total change in Google’s stock price since 2014 can be broken down into 4 underlying components: the change in revenue, net income margin, number of shares and P/E multiple. Google’s share price has benefited from growth in revenue and net margin, and faced headwinds from a decline in P/E and increase in number of shares. Notably, the P/E multiple had been hampered due to privacy concerns.

Trefis explains why Google’s stock grew ~100% in 5 years in an interactive dashboard along with our forecasts and estimates for the company. You can modify any of the key drivers to visualize the impact of changes on its valuation. Additionally, you can see more Trefis technology company data here.

A Quick Look At Google’s Revenues

Google primarily makes money through online advertising, purchase of digital content on Google Play, sale of hardware and sales of cloud subscription (Google Cloud Platform and G Suite). Google’s total revenue ($136 billion in 2018) can be attributed to the following three segments:

• Google advertising ($116 billion in 2018 revenues, contributing 85% to total revenues): Segment revenues were derived from online advertising across Google’s own websites and from placement of ads across third party websites.
• Google other ($20 billion in 2018 revenues, contributing ~15% to total revenues): Segment revenues were derived from the sale of digital content on Google Play, hardware and sale of cloud subscription.
• Other Bets ($1 billion in 2018 revenues, contributing <1% to total revenues): This segment houses all of Google’s incubation projects and bets on nascent technologies.

#1. The biggest change in revenue has been in the company’s cloud business (which is part of Google Other).

While the management does not break out its cloud revenues, in 2Q 2019, Google disclosed that its cloud business had a run rate of $8 billion per year. Total Revenue increased by 107% to $137 billion in 2018 from $66 billion in 2014. In Q2 2019 revenue reached to $39 billion (19% y-o-y). We expect 2019 revenue to reach $171 billion (25% y-o-y). The trends in Google’s various revenue streams over recent years is as follows:

• Google Advertising revenue increased by 93% to $116 billion in 2018 from $60 billion in 2014. In Q2 2019 revenue reached to $27 billion (18% y-o-y). We expect 2019 revenue to reach $120 billion (25% y-o-y).
• Google other revenue increased by 229% to $20 billion in 2018 from $6 billion in 2014. In Q2 2019 revenue reached to $6 billion (40% y-o-y). We expect 2019 revenue to reach $28 billion (40% y-o-y).
• Other Bets revenue increased by 82% to $1 billion in 2018 from $0 billion in 2014. In Q2 2019 revenue reached to $0 billion (12% y-o-y). We expect 2019 revenue to reach $1 billion (25% y-o-y).

#2. Net Income grew with Google’s revenues from 2014 to 2018, while Net Income Margins have remained stable

• Google’s Net income increased from $14 billion in 2014 to $31 billion in 2018 – indicating an improvement in net income margin figure from 21% in 2014 to 22.5% in 2018. We expect net income margin for 2019 to be 17% (-540 bps y-o-y), translating into a net income of $29 billion.

#3. P/E Multiple for the company contracted from 25 in 2014 to 23 in 2018 despite strong revenue gains due to sentiment issues around privacy

• Per Trefis estimates, the EPS for the next year is likely to be $42.02. Taken together with a P/E of 31x, this represents a fair value of $1295 for Google’s Stock.