Alphabet (NASDAQ: GOOG)(NASDAQ: GOOGL), better known as Google, is one of the world’s most powerful tech companies. Although some companies have more revenue, Google is more ubiquitous than its rivals, with at least seven products that boast a billion users. The company is also highly profitable and — amazingly — still growing quickly despite its massive size.
The question enterprising investors might ask here is, “Is GOOG still a millionaire-maker?” While Alphabet made countless investors wealthy in years past, it is so big now that you have to wonder whether this can continue. In this article, I will attempt to answer that question, ultimately concluding that Google will probably do well, but not the kind of “well” that makes millionaires from nothing.
Alphabet’s size is a problem
Have you ever noticed that our culture worships big things? We worship big buildings, big ideas, and big bank balances. There seems to be an innate human tendency to idealize whatever is large, probably because size has an association with power. However, from an “economic growth” perspective, size is a negative rather than a positive. The larger a thing grows, the more absolute growth is required to achieve the same amount of percentage growth as in the the past.
For example, if a company grows 100% from $5 to $10, it takes $10 to achieve that 100% all over again. Should this company’s value come to equal the world’s money supply, then no more relative growth is possible: it already owns all the assets that could fuel its growth.
This phenomenon is a problem for Alphabet. The company certainly is not worth the world’s money supply, but it is a large percentage of the investable universe in which it operates. Warren Buffett recently said that Berkshire Hathaway was 6% of the universe it operates in. That’s a problem for Buffett, and Alphabet faces a similar problem. The U.S. tech sector is worth $26 trillion going by the value of the NASDAQ-100, and Alphabet is worth $2.2 trillion. So, Alphabet is 8.5% of the universe it operates in. That is likely to have a negative impact on its future growth.
Why Alphabet will continue doing well
Despite Alphabet having an obvious scale issue, it will likely keep doing well as a business. Specifically, it enjoys this laundry list of advantages:
- +7 products with over a billion users.
- 4.5 billion total users, more than half the world’s population.
- A 90% market share in Search.
- A very high market share in long-form video.
- Valuable intellectual property.
- A 26% net income margin (“profit margin”).
- A 17.3% free cash flow margin.
- A 30% return on equity.
This is a pretty enormous list of advantages. You would expect a company like this to keep making lots of money. However, the sheer fact of Google’s size means that it is unlikely to continue making millionaires out of people who don’t have hundreds of thousands already. It will keep earning many dollars, but the percentage growth in dollars will likely be less than it was in the past.
Any Canadian stocks with this problem?
This being the Motley Fool Canada, I’d be remiss if I didn’t include a tie-in with Canadian stocks. One Canadian stock that may face the scale issue Alphabet faces is Royal Bank of Canada (TSX: RY). It is certainly no trillion-dollar behemoth, but its $207 billion market cap is quite large as a percentage of Canada’s equity markets. For it to grow rapidly, it would have to either acquire its rival mega-banks, or else take their customers.
Given the high cost of acquiring customers for banks (it requires significant advertising spend and competitive interest rates), the customer acquisition approach is unlikely to work. Likewise, buying up all of its rivals would cost more than Royal Bank has. So, Royal Bank growing rapidly in Canada is unlikely to occur — although investing heavily in its foreign operations might do the trick.
