Episode 20 | A Closer Look at Google: Urgency of AI, Leadership, and Future Growth

In Episode 20 of "Market News with Rodney Lake," Rodney Lake, Director of the GW Investment Institute, assesses Google’s current standing amidst the fast-evolving AI landscape. Analyzing the company’s management under a non-founder CEO, Sundar Pichai, Lake discusses Google’s overreliance on its core platforms—Search and YouTube—and questions its ability to compete in the AI race with tools like Gemini. While acknowledging Google’s solid balance sheet and steady presence in the market, Lake scores the tech giant at a 7.5, citing a need for greater urgency and innovation to stay competitive. Tune in to hear Lake's take on how Google can sustain its growth.

Transcript

Thank you for joining Market News with Rodney Lake. This is a regular program for the GW Investment Institute where we talk about timely market topics. I'm Rodney Lake, the director of the GW Investment Institute. Let's get started. Welcome back to Market News with Rodney Lake. I'm your host, Rodney Lake. We're coming from the Rick and Dawn Family Innovation studios here in the Duquès School of Business.

Well, the building Duquès Hall in the GW School of Business. Excuse me. Next up, today we're going to be talking about Google, another top holding in our portfolio. Google—the parent company is Alphabet, so we'll use those interchangeably today. Reminder disclaimer: this is not investment advice. This is for entertainment and educational purposes only.

All right, with that out of the way, Google is one of the largest holdings for the GW Investment Institute. As we get started on our podcast, thank you for tuning in, whether you’re returning or joining us recently. We’re going to talk about this company through the lens of the GW Investment Institute framework: business management, price valuation, and balance sheet. These are the four components. This won’t be a deep dive. For today's episode, we’ll address each component briefly.

I'm sure everyone has heard of Google and may use it daily, but it's a larger holding in our portfolio, so we're going to talk about it. We’re asking our analysts to think about how we should think about Google moving forward, especially regarding the business. Let's get a few specs on Google. Most people know it primarily as a search and advertising business. The market cap is $2 trillion, making it one of the largest in the world, but it’s still essentially a search business.

They have other ventures. Probably the most well-known is YouTube, which they acquired for $1 billion. Everything else now is secondary to that. They have moonshot projects and ventures like Google Ads and Waymo. Still, nothing as consequential as search has emerged. Embedded in there is DeepMind, which they acquired years ago. They created transformers in the ChatGPT world, but OpenAI was first to market this technology effectively.

So the principal business remains search, with YouTube being a notable piece. Some concerns are whether it’s overly reliant on an older business model, which has been a home run since it went public in the late '90s. The business has done incredibly well.

Let’s look at characteristics of the current business. The market cap is $2 trillion, as of late October 2024. Talking about revenue, it generates $328 billion as of June 30th, for the last 12 months. Revenues grew about 13%, which is solid growth for such a large company. However, projections suggest it might decline by year-end, adding downward pressure on valuation. In terms of margins, gross margins are 57%, which is excellent, with net margins at 27%.

It also generates $60 billion in free cash flow—a robust metric for this business. Now, why might people be concerned about Google right now, or Alphabet as the parent company? Google search is still the main revenue driver.

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So if you're concerned that the AI world is going to start taking over, and specifically if you're thinking about OpenAI and their ability to do search as opposed to Google, are people actually going to migrate? Bing. You know, people, I think there are some people that use Bing. I'm not sure. But I think they're out there.

So are these other types of ways to search using AI. And so when you talk about ChatGPT or Anthropic with Claude, are they going to make a dent in this business? Time will tell. And so far, that has not really happened. And Google really still dominates this—a monopoly within search. They talk about, we're not a search company; it's an advertising company we own.

You know, a small piece of that. But in search, they dominate this and they own this. But people are concerned because AI is chipping away at the heels of this market dominance. Buffett talks about the moat. You can see people making a dent in this moat, people making a little bit of progress here. And so I think it's a legitimate concern when you talk about this.

All right. So when we talk about, you know, where the business can go, well, they have their own answer in the form of Gemini in AI. And so, as everyone is talking about AI as everything, their searches are now being powered by Gemini. And if you type in searches now, you get this sort of Gemini setup at the top of the bar on the page.

They're definitely incorporating that. You can use Gemini in a variety of different ways to create images. They have a paid version, just like they do on OpenAI for ChatGPT. And so you can pay a monthly subscription. Then that gets incorporated into your Google Docs, Google Sheets, and their office suite of products.

And so that can be a good thing. Now, is that going to translate into people being stickier, using their office setup, or continuing to use their search, where they still dominate? On the advertising revenue side, again, I think this is something to watch for and be very aware of because that landscape is changing quickly, and people are deploying a lot of money to disrupt this business—not specifically search, but just the way we’re doing things.

And how do we become more efficient, search being a part of that? Is there a better way to do it such that you don't get a list of random things, but rather a very curated response back to exactly what you want? And they're obviously working on that. Gemini was first called Google Bard, and now it's Gemini.

They're absolutely making progress there. Can they keep up? That's a big question. Another big part of the business is cloud. So you talk about Microsoft Azure, a big player, and of course, AWS, which had a seven-year lead that we've mentioned before. Now you have Google Cloud and also Oracle. When you look at the large government contracts that have been awarded, those are the four players you see.

They've made a lot of progress there. Is it enough to be a meaningful part of the business? Yes, right now. But is it still subservient to search? Yes. But it's an important piece. They'll continue to grow that business. In the short term, at least in the medium term, it looks likely that as people move things from on-premises to the cloud.

That will continue to be an important part of the business, and I think that's a positive for them. But really incorporating AI as part of their setup will be super important. All right. Now let's move on to management. We'll come back to the business, but while we're here, let's give a score.

When we're talking about this, we go from 1 to 10, with 10 being the best. Right now, this is probably a seven. And I would say a seven because—and you could say an eight depending—because there is some idea that people are chipping away at their dominance. I think that's legitimate.

I think you should be concerned about that. We are thinking about that, asking our analysts to consider this, and how this is likely to play out. So I think that's a seven. Now, management. You had the founders Larry Page and Sergey Brin running this company. They brought in Eric Schmidt long ago.

Then Larry Page took over as CEO. But now you've had a shift to Sundar Pichai, who's running the business. So a non-founder CEO is in there now. Eric Schmidt was a non-founder but was in really early. So kind of a second wave of founder.

You could call him that, as he really took the business from an idea and a clever setup to a proper business. When Eric Schmidt was there, Larry Page took it back over. But now you have a non-founder CEO in there, and they've been prioritizing AI. Time will tell how this works out.

He seems to be doing a reasonably good job; this is obviously a big job to take over a company with the founders still around. Time will tell. The focus on AI, I think, is deserved. And it seems that's the direction they're going. I think the criticism people have—not just of Sundar—is how quickly they're moving with AI. They think they're not moving quickly enough.

They developed the transformer, had DeepMind early, but didn't commercialize much of it. Then you saw ChatGPT come in and kind of steal their thunder and really get this market started, becoming the main topic when discussing AI and large language models in particular. Google was really first.

So why couldn't they take this in-house knowledge, this expertise on AI, and transform it into a marketable setup faster than a startup? If you consider it, that’s the nature of startups, right? The incumbents get beat by startups.

Now, you wouldn't think of Google as an incumbent. But certainly, at this point, it is. In the history of Google, you’d say it's a startup. But it’s no longer in the startup category. It’s a massive company. Maybe it’s challenging for them to innovate at the same rate as a smaller company, which OpenAI was at the time and still is, but it’s become much larger over the last couple of years and done some funding rounds—nowhere near the size of Google, of course.

The management seems to be doing a reasonably good job. You've had a shift over time from the founders to Eric Schmidt, back to one of the founders, Larry Page, and now to Sundar Pichai. We’ll see how it works out. The focus on AI, I’d say, deserves credit.

I’d probably give management a seven at the moment because I don’t necessarily think they have the same level of urgency that they need in this space. But we’ll see. They don't seem to have the ability to quickly transfer some of those moonshot projects into proper businesses, and they haven't really done that.

And it's still overly reliant on search, as a main driver for revenue and growth. So all that said, I probably give that a seven again, reasonably good management, but I wouldn't say overly impressive management at the moment. No disrespect. All right. Moving on to the valuation. So for this company, because it's a more mature company, I think we can use a price to earnings ratio, here.

And if you look at the PE right now that the forward which is what we care about, what do we think it's going to happen in the future? The forward is 21.5 times, approximately. So this is certainly not a really high multiple for, for Google and certainly not a high multiple for, you know, a tech company.

And so when you look at sort of where the highs, you know, what's the high, Ben, you're talking like almost 60 times. And the lows 18. Yeah. So these are not, you know, this is a pretty wide gap and we're much closer to, you know, where the valuation has been on the low side versus the high side.

The median is closer to 29 times. And so we're below the median. We're certainly well off, the high. And we're actually closer into where the low was, which is, back in 2022. So, you know, you're definitely not trading at a premium. You're definitely, you know, historically at a discount to where it's traded over the last ten years, but, you know, it could be deserved.

And why this could be deserved is because people are concerned about the concentration which we mentioned in search that's driving their business, the ability or the inability in this case to get those really moonshot ideas out into proper businesses, the inability to take the AI that they were ahead on at one point and get that in, monetize that, before others, you know, caught up very quickly.

And you would have to say, if you're using the large language models, this is my estimation opinion inserted here is that if you're using AI, I would say that ChatGPT is still, the leader in this when you're when you're using these large language models and I don't use them for every use case. And so I use them for my own research and other things.

But when I interact with these models and I try to use as many as I can, I would rate, Gemini behind ChatGPT, certainly the old one and the four. I would rate Gemini behind that. Another model that's coming on strong would be grok to it as an example. So there's competition in there. And Claude, from anthropic.

And so, you know, this is a competitive set, that they have to work with. And so when you say, well, what is the proper valuation for this company, you have to look at their competitive set. What's the competition looking like in their business and has their margins eroded? Do they deserve a premium. Because they have a big moat around the business?

It seems like possibly not. And when you look at this valuation, the market seems to think that otherwise it would trade at a higher multiple. Again, it's closer to an all time low than an all time high or even median. When you talk about the median, the meeting is significantly higher than we are. Right now. So the market is has their concerns.

And, you know, the market is sometimes right and sometimes wrong over the long term. The market usually gets it right, by the way. You know, in the short term, it's a voting machine. In the long term, it's a weighing machine. Now, hard to know. Is this a call on the valuation a short term phenomenon? Can Google get its, you know, sort of act together around AI more quickly than it has in the past.

And now with this sort of catalyst with ChatGPT, in the focus, really start to turn that, you know, those ideas, that they have developed and, you know, all the expertise that they had, collection of talent and translate that into, market cap, translate that into earnings, translate that into a higher multiple. Again, I think time will tell on that.

But I think it's deserved that, that there's multiples here. But you know that makes it for a more favorable score because okay, it's it's certainly you're not paying up for this, company at the moment relative to where it has been in the past. And so, you know, again, right now, you know, lower than it has been over time.

So I probably give the valuation score something like a seven. And then when you talk about balance sheet, here's where you're going to get a ten. You know, you're talking about a big pile of cash, $100 billion, 27 billion. But even if you make it, you know, 27.8 billion in cash or net debt. And so you're talking about, you know, just do round numbers, 70 billion plus of net cash on the balance sheet as of June 30th.

So this is going to help you sleep at night. And we talked about this before. You're generating 60 billion, in free cash flow. So you're generating a lot a lot of free cash. You have net cash on the balance sheet. And you could argue that they're going to need this cash. So one of the arguments is that, okay, why do they have so much cash?

Well, if this AI cycle, is going to be as competitive as we talked about, it will deserve big investments. And these companies are all making big investments in the billions of dollars, it for single companies and you're talking trillions, for the industry. And so for this upgrade to all their infrastructure for Google Cloud to build, these algorithms to make YouTube, which we don't talk too much about.

But YouTube is obviously a big property within, that. And when I talk about YouTube, I include that in search that it's the number two search engine behind, behind Google. And so, you know, those are one and two for, I should have cut out a little bit more, possibly on the business side, but super clear, when you talk about search, you're talking about traditional search and YouTube and they are dominant there.

But again people are concerned that that is that overreliance on those categories. Is the Achilles heel for Google. But back to the balance sheet. The balance sheet you're talking ten here. There are no concerns for the balance sheet for Google. You know, net cash, $70 billion generating 60 billion. The only mild concern but it's not current concern is how much of this cash are they going to need to deploy to, you know, keep up with this AI arms race?

It seems like they have enough. Certainly. And they're generating enough. So for the moment, I think this is a ten. So now let's recap here. Go through all the scores you're talking. We've given mostly sevens here in the ten, you know. So that kind of comes out depending on if you want to make some adjustments along the way.

You're talking about a 7 to 5 for the business, something like that. Or 7 to 5 for everything when we talk about the composite score. But the business again, I think it's a seven. I think the concerns around the overreliance on search and on YouTube have come to the forefront right now.

And people are worried about that. Can they make Gemini actually, really be one of the next things that really works for them and integrate it to be a solution provider to make everybody more productive? Time will tell on that. They haven't been as quick to move. The sense of urgency needs to come back to Google, and we'll see if it does.

But that's reflected in the valuation. You get to the management side, and you have a non-founder CEO who seems very capable but not with the same drive as a Larry Page or even an early days Eric Schmidt when they were transforming the business. So can we see a bit more sense of urgency?

Seven on that. And then you get to the price valuation, probably closer to an eight because you're not paying up for this. And then ten on the balance sheet. So if you're talking between a seven and an eight, depending on how you really want to score each individual component.

If I say seven, and I said 7 to 5 before, maybe call it a seven and a half and pick the middle there. But it's not a high score for this great company. You would think, possibly, if you didn't go through each piece, that it would not be rated at a seven and a half or 7 to 5.

But I think there are legitimate concerns around the moat, around the business, and I think that's reflected in the valuation piece. You have a non-founder CEO who doesn’t have the same level of urgency. It doesn't seem like it. Again, no disrespect—they're doing a good job, but I think there needs to be a bigger sense of urgency on how they translate Gemini into products for the company's growth moving forward.

So collectively, again, between the seven and eight, seven and a half, if you like, 7 to 5 if you like. But fantastic overall in our portfolio over the time we've held it. But it really is a different time now. And it does require, like any other investment, that you look at it on a constant basis.

Yesterday's wins are not today's wins. You really have to re-underwrite these things all the time. Business changes, dynamics change, the market changes. So even for the same company, it has different management, different businesses, different threats, different advantages. And you have to reconsider those all the time.

That's what we ask our analysts to do every semester, fall and spring, in every 15-week period. I think that's one of the big advantages we have at the GW Investment Institute—that our analysts change. For a lot of people, that's a disadvantage, but in this way, it can be an advantage because we have a fresh set of eyes.

I think Google deserves a fresh look because it’s in a different space. The big catalyst was the change with ChatGPT and the kickoff in the AI arms race, and so we'll continue to watch. Again, it's a good company. It’s a solid company. We'll continue to re-underwrite all of our companies, including Google.

That's a wrap for this show. I want to thank everybody and all of our listeners. The call to action is, you know, put it in our comments. Is there a company, an idea, that you’d like us to look at? Please let us know. And with that, that's a wrap for Market News with Rodney Lake.

See you in the next episode. Thank you.

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