An Activist Investor Is Going After Alphabet. Does That Make the Stock a Buy? – The Motley Fool


- Advertisement -

Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.
Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people attain financial freedom through our website, podcasts, books, newspaper column, radio show, and premium investing services.
Motley Fool Issues Rare “All In” Buy Alert
You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More
A big trend in the technology industry this year has been rationalizing expenses and employee layoffs. Companies like Meta Platforms and Amazon have begun letting large chunks of their employee base go after realizing they hired too many people in 2021 and years prior. So far, technology giant and trillion-dollar enterprise Alphabet (GOOG -2.01%) (GOOGL -1.88%) has avoided such layoffs and — perhaps surprisingly — has added over 36,000 new employees over the last 12 months. 
TCI Fund, a large shareholder of Alphabet stock, recently wrote to its management team in an effort to rein in its employee costs to improve profitability. Does that make Alphabet stock a buy today?
The TCI letter is short, straightforward, and brings up some reasonable points for Alphabet’s executive team to consider. First, the fund thinks Alphabet’s headcount is simply too high. Alphabet is the owner of assets like Google Search, Google Maps, and YouTube, which are all highly scalable and rely on outside sources to fulfill both supply and demand. Yes, these assets are extremely complex, but TCI thinks they can be run much more efficiently. The evidence is in Alphabet’s employee count growth. From 2013 to 2017, employee count grew by 14% annually. But then, inexplicably, from 2017 to the third quarter of 2022, Alphabet accelerated hiring and grew employee count by 20% a year, more than doubling over that time frame.
Second, TCI presented some data showing that Alphabet spends much more per employee than other technology peers. In 2021, median compensation at Alphabet was roughly $296,000 a whopping 67% higher than at competitor Microsoft. Yes, Alphabet employs some of the smartest people in the world who deserve to be paid well, but so do the other large technology companies. There’s no reason for Alphabet to pay them more for equivalent positions.
To sum things up, TCI thinks Alphabet has an easy path to raising margins by laying off some employees and reducing salaries. According to its analysis, a 40% operating margin at Google Services (which excludes Other Bets and Google Cloud) is easily achievable. For reference, last quarter the segment had a 25% operating margin, even with all this employee and compensation bloat.
Let’s do some rough analysis to see how a change in employee costs and a 40% operating margin could impact Alphabet’s earnings. Over the last 12 months, Google Services brought in $255 billion in revenue. At a 40% operating margin, that would equate to $102 billion in operating income, which is significantly higher than the $78.5 billion in total operating income Alphabet has brought in over the last 12 months.
Of course, this doesn’t include Other Bets and Google Cloud, which are both money losers for Alphabet at the moment. But Google Cloud is inching closer toward profitability and growing revenue at a fast rate (37.6% year-over-year growth in Q3 2022). Other Bets is a huge money loser, with $20 billion in cumulative losses over the last five years. TCI is recommending Alphabet pull back some expenses over at Other Bets in order to improve consolidated profitability as well.
I think if Alphabet goes through some of TCI’s cost-cutting ideas it will be great news for the stock. At today’s prices, the stock has a market cap of $1.27 trillion. Excluding Google Cloud and Other Bets, and assuming Google Services could hit $102 billion in annual profits, the stock would trade at a price-to-operating income (P/OI) ratio of around 12.5, which is much below the market average. Plus, Alphabet has over $116 billion in cash on its balance sheet that it can return to shareholders through share repurchases.   
For a company with a consistent track record of growing its revenue and a dominant position as one of the leading technology companies worldwide, Alphabet stock looks like an easy buy at these prices

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool’s board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Brett Schafer has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Amazon, Meta Platforms, Inc., and Microsoft. The Motley Fool has a disclosure policy.
*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.
Market-beating stocks from our award-winning analyst team.
Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 11/21/2022.
Discounted offers are only available to new members. Stock Advisor list price is $199 per year.
Calculated by Time-Weighted Return since 2002. Volatility profiles based on trailing-three-year calculations of the standard deviation of service investment returns.
Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool’s premium services.
Making the world smarter, happier, and richer.

Market data powered by Xignite.


- Advertisement -


Please enter your comment!
Please enter your name here

Share post:




More like this

Ghana, creditor panel agree on debt restructuring, paving way for IMF cash

Ghana has finalised a pact with its official creditor...

Nigeria strikes deal with Shell to supply $3.8 billion methanol project

Nigeria has struck a deal for Shell (SHEL.L), opens new...

Africa’s $824 billion debt burden and opaque resource-backed loans hinder its potential, AfDB president warns

Africa's immense economic potential is being undermined by non-transparent...

IMF: South Africa needs decisive efforts to cut spending

South Africa needs more decisive efforts to cut spending...