Of the Magnificent Seven companies, Alphabet (NASDAQ:GOOG) stock remains the one I’m least confident about over the long haul. That’s not to say there aren’t many positives about the company. I recently noted that Alphabet stock was a buy because of its free cash flow. However, I also said it wasn’t the best of the Mag 7.
Media journalist Simon Owens produces an excellent Substack newsletter about content creators. I highly recommend it. He often writes about YouTube and its excellent business success.
In February, while discussing why a YouTuber will direct a future Best Picture winner, Owens trotted out several stats about the increasingly important business within the Alphabet empire.
The figure that caught my attention was that YouTube paid out more than $70 billion over the past three years to content creators. How’s that for treating the talent right?
Businesses that nickel and dime the people responsible for your growth don’t deserve anyone’s time of day. Owens makes it clear that YouTube is the fast track to riches. That’s great news for shareholders.
Thanks to YouTube, Alphabet stock is a Buy. Here’s why.
YouTube and Alphabet Stock
Google, the company’s former name, acquired YouTube for $1.65 billion on Oct. 9, 2006. We’re coming up on the 18th anniversary of the acquisition, arguably one of the greatest in American M&A history. When adjusted 3% for annual inflation, today’s price would be $2.81 billion.
Owens points out it generates more than $9 billion in ad revenue per quarter. Even at a 10% contribution margin, that’s $3.6 billion in profits annually. It’s the gift that keeps on giving.
Mark Cuban, the man who himself made a smart call to sell his business, Broadcast.com in 1999 for $5.7 billion at the height of the dot.com boom, said after the deal was consummated in July 2000, “only a ‘moron’ would purchase YouTube,” ZDNET contributor George Ou wrote in October 2000.
In a humorous turn, a senior executive at Yahoo, who significantly overpaid for Cuban’s company, said in 2011, nearly five years after Google acquired YouTube, that the search engine firm was “still crazy” for overpaying for YouTube.
Hmmm. Where is Yahoo today?
As the Brits say, it’s just brilliant.
A Bigger Piece of the Alphabet Pie
Inc.com tech columnist Jason Aten said some things in February 2020 that foreshadowed better times ahead for YouTube.
“Even so, it’s clear YouTube is becoming even more important for Google. YouTube says users consume over 1 billion hours of video single day. That’s a huge amount of content that Google can show ads with. And video represents far more unique opportunities to monetize content than normal search ads,” Aten wrote.
In 2019, U.S. YouTube users spent an average of 39.7 minutes per day viewing videos. That increased to 43.7 minutes in 2020 and 47.5 minutes this past year.
While the increase in time spent per day might be slowing, as long as the user base is rising and the ad prices it can charge, YouTube will continue to grow in importance at Alphabet HQ.
In early April, Bloomberg Opinion columnist Dave Lee suggested that the company be spun off into a separate public company.
“With the company’s top brass fixated on solving its lackluster start in the AI wars and revitalizing its cloud business, the best thing for YouTube’s future is to be spun out into a separate concern that can cement its place, as analysts MoffettNathanson describe it, as ‘The World’s Leading Media Company,” Lee wrote.
Lee quotes Needham analyst Laura Martin, who pegs YouTube’s market value at $423 billion.
I get where Lee is coming from. Held within Alphabet, investors don’t appreciate how important the business is to the company. And that’s the problem. Alphabet management does understand, which is why we probably won’t see a spinoff anytime soon.
YouTube covers many of Alphabet’s warts.
Don’t Forget the Cloud
While many investors feel Google has mishandled its AI strategy, its Q1 2024 results demonstrate that its cloud business benefits greatly from its customers’ push into this area. In the quarter, Google Cloud earned $900 million from $9.6 billion in revenue. The unit’s profit was $227.6 million higher than analyst expectations.
The most considerable risk to Alphabet from AI is that consumers move to chatbots such as ChatGPT to find what they’re looking for, circumventing Google Search and cutting into its nearly $200 billion annual revenue.
Given the 28% hike in Google Cloud revenue in the quarter, a growing cloud business could partially cover any hit the company takes in search.
YouTube, free cash flow, and Google Cloud make Alphabet a long-term buy.
On the date of publication, Will Ashworth did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.