Friday, 6 March 2020

Alphabet:Key Financial Ratios 2020


ALPHABET: DIVERSIFYING ITS PRODUCT PORTFOLIO

Slowly but surely, Alphabet is reducing its dependence on advertising revenues. Between 2014 and 2019, the proportion of advertising revenues out of total revenues has decreased from 89.87% to 83.29%. On average, Alphabet invests around 15 to 16% of its revenues on research and development every year. 


As advertising revenues stabilize (from the developed economies), Alphabet is constantly on the lookout for new sources of revenues. The race to the two trillion dollar-market cap is on (!) and the US tech giants are on the prowl with war chests of cash.
 
TRAFFIC ACQUISITION COSTS (TAC)

TAC represents the amounts paid to Google Network Members primarily for ads displayed on their properties and amounts paid to Google distribution partners who make available Google search access points and services. Google distribution partners include browser providers, mobile carriers, original equipment manufacturers, and software developers. (Annual Report 2019)


Google's TAC have increased by about 1% in the past five years from 21.28% to 22.33% as a share of revenues.

GOOGLE ADVERTISING MONETIZATION METRICS


Paid clicks for Google properties represent engagement by users and include clicks on advertisements by end-users related to searches on Google.com and other owned and operated properties including Gmail, Google Maps, and Google Play; and viewed YouTube engagement ads (certain YouTube ad formats are not included in Google click or impression based metrics). 

Impressions for Google Network Members' properties include impressions displayed to users served on Google Network Members' properties participating primarily in Ad Mob, AdSense and Google Ad Manager.


Cost-per-click is defined as Google's click-driven revenues divided by total number of paid clicks and represents the average amount Google charges advertisers for each engagement by users.


Cost-per-impression is defined as Google's impression-based and click-based revenues divided by total number of impressions and represents the average amount Google charges advertisers for each impression displayed to users.


The % change in the paids click is increasing at a decreasing rate and cost per click change % has been decreasing in the past four years. As the number of paid clicks increase the cost per click is expected to reduce as ad revenues stabilize.
The % change in impressions which is being reported from YE 2017 has increased by 9% for the year ending in Dec 2019. The cost per impression has increased by 1% for the year ending in Dec 2019.



ALPHABET: MARGINS and PROFITABILITY RATIOS


1. Gross Profit Margin = Gross Profit/Total Revenues
2. Operating Margin = EBIT/Total Revenues
3. Net Profit Margin = Net Profit/Total Revenues
4. Return on Invested Capital = EBIT*(1-t)/(Book Value of Debt + Book Value of Equity - Goodwill- Cash*) Goodwill has been excluded from invested capital.
Here for the purpose of Cash*, cash, cash equivalents and short term investments have been included.
5. Return on Equity = (Net Income-Interest Income)/(Equity - Goodwill - Cash*)
Here again for the purpose of Cash*, cash, cash equivalents and short term investments have been included. Goodwill has been excluded from equity)

Although, Alphabet's gross margins (55.58% in 2019) are on the rise, we can see that the operating and net profit margins are around 21% by year end 2019. Alphabet invests heavily in R & D and the operating margins on the new segments of revenues are much lower when compared to advertising revenues.Within advertising revenues, You Tube Ads monetize at a lower rate than other advertising revenues. (Remember R & D is not capitalized as per existing accounting standards)



Alphabet's return on invested capital has reduced from 27.52% in 2015 to 21.88% in 2019. We cannot ignore the base effect of Alphabet's advertising revenues of $ 134.81 billions which account for around 30% of global digital ad spend.Google advertising revenues at least from the developed markets are showing signs of maturity. Google is the market leader by far, when it comes to digital advertising revenues but it faces increased competition from the likes of Facebook, Amazon and others for the global advertising pie.



Alphabet's return on equity has declined from 51.96% in 2015 to 47.22% in 2019.
 


ALPHABET: LIQUIDITY AND SOLVENCY RATIOS


1. Current Ratio = Current Assets/Current liabilities
2. Quick Ratio or Acid test ratio = (Cash+ Short term investments +Accounts Receivables)/Current liabilities
3. Cash Ratio = (Cash and Cash Equivalents + Marketable Securities)/Current liabilities
4. Debt to Capital Ratio = Debt/Debt + Equity (Debt includes all interest-bearing debt)
5. Debt to Equity Ratio = Debt/Equity

Alphabet has heaps of cash, so liquidity position is very healthy as shown below. Working Capital as a proportion of revenues has reduced from 0.94 to 0.66 in the past five years.


Alphabet carries very little interest bearing debt on its balance sheet as shown in the figure above.


The only scare with tech giants is that, they may burn their hands at unworthy acquisitions.

(Inspired by Prof. Damodaran, Data Source: https://in.reuters.com/companies/GOOGL.OQ/financials, Alphabet Annual Report 2019)

Up next: Alphabet: DCF Valuation

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