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A Slightly More Frugal Google

Long thought of as one of Silicon Valley’s more improvident spenders, Google has lately been garnering a reputation as a skinflint. The reality, of course, is more complicated.

Last year saw an ambitious restructuring that created the parent company known as Alphabet. This separated the core Google business from the company’s other ventures. The idea was to give greater transparency to the core business as well as moonshot projects now termed “other bets” in the company’s financial reporting.

This year has seen several reported shake-ups within those projects, creating an image of a more cost-conscious Google. Ventures such as fiber-to-home, drone delivery, robotics and home automation have seen their strategies shifted and some executives depart. The company’s self-driving car project has fared better; it has “graduated” to the level of a stand-alone business. The rub is that this move effectively puts it on a clock to start generating actual returns within a few years.

Executive departures hint of internal dissatisfaction with the new approach. Tony Fadell, who ran the Nest home automation business that Google bought in 2014 for $3.2 billion, publicly dinged the “fiscal accountability era” as he was leaving.


Fiscal accountability is hardly an unreasonable expectation for a company now well into adulthood, at least by Silicon Valley standards. But the reality is that Alphabet’s financial results don’t reflect those of a penny pincher. At the end of the third quarter, trailing 12-month operating margin as a percentage of net revenue was 32% compared with 31% for the same period the previous year. Alphabet has expended about 20% of revenue on research and development for the first nine months of 2016, equal to the year before. It also has grown its workforce by 13% in that time, slightly above head-count growth for the same period last year.

The complicated truth is that Google was never as profligate as it seemed, despite indulgences like free, gourmet meals for employees and some far-out projects, such as an attempt to build a jetpack.

And the new Alphabet isn’t significantly different. What last year’s shake-up accomplished was providing clarity that—at its core—Google is a powerhouse with robust profit margins and a surprisingly strong growth for a business on pace to pull in nearly $80 billion in advertising revenue this year. So losing $2.5 billion on its other bets over the past nine months looks manageable against the $20 billion in operating income that core Google has racked up in that time.

That should also help the stock, which cooled significantly this year after a big run-up last year. At just 19.8 times forward earnings, Alphabet trades at a discount to internet peers Facebook’s and Amazon.com’s multiples of 23 times and 87 times, respectively. Even the most frugal investor should agree.


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