If you were to boil the reason why Bill Ackman bought Alphabet to one idea, it would be the firm’s sustainable competitive advantage. Another way of describing that is an economic moat, a term made famous by Warren Buffett.
Beyond the headline reason, however, are a number of key reasons why Ackman’s Pershing Square took a stake in the Search giant.
So let’s get to it.
Why Did Bill Ackman Buy Alphabet?
At CNBC’s Delivering Alpha conference, Bill Ackman stated that he bought Alphabet because fundamentally it was undervalued.
We wanted to explore whether he was right and began our investigation by looking at what Wall Street analysts think of the stock. As it turns out, they are overwhelmingly in agreement with Ackman. 43 analysts cover Alphabet and the consensus price target for the firm is $151.14 per share.
Our own analysis is slightly more conservative. After running a discounted cash flow forecast analysis, we calculated fair value to sit at $149.28 per share, representing upside potential of 12.8%.
Beyond the valuation argument, Ackman stated that Alphabet is a leader in artificial intelligence and he expects it to remain so for some time.
Ackman Expects Alphabet To Be an AI Leader
On stage, Ackman countered the argument that Alphabet had fumbled the “AI ball” when competing against OpenAI. Instead he claimed the company had fumbled its public relations campaign around the launch of Bard, its ChatGPT competitor.
Where Ackman sees Alphabet as having an enormous competitive advantage against its peers is its unique and unrivaled access to legally gathering data.
Great artificial intelligence products need to train on massive datasets, and Alphabet is perhaps unrivaled in its data coverage thanks to its diverse and leading products that range from Search to YouTube, and from Cloud computing to Gmail and Maps.
Alphabet Financials Support Ackman
The more you dive under the hood of Alphabet’s financials, the more compelling they become. For example, Alphabet has sustained very high returns on invested capital (ROIC) for the past few decades. Currently the company’s ROIC sits at 22.5%, a figure only possible after 25 years in business when a wide economic moat exists.
Value investors won’t find the company’s price-to-earnings overly compelling at 27.5x but Alphabet has frequently traded at a premium to earnings. Buffett might describe it as a great company at a fair price.
They key attribute that makes the company attractive is its sustained revenue growth through thick and thin. Ultimately, impressive top line figures translate to the bottom line, and that’s long been true for Alphabet.
To emphasize how good a business model Alphabet enjoys, look no further back than 2020 when the rest of the world was struggling. That year Alphabet posted revenue gains of 12.5% and 41.2% the following year.
Even in 2022 when the overall stock market tumbled by around 20%, Alphabet grew its revenues by 9.8%. When we went back ten years, we couldn’t find a single year when the revenues declined year-over-year.
Better still, over the last decade operating income has almost quintupled from $15.4 billion to $74.8 billion.
Yet beyond what’s apparent for most investors to see, Alphabet has a few more aces up its sleeve that Ackman likely spotted, even if others did not.
5 Reasons Why Ackman Bought Alphabet
For years, rumors spread around Silicon Valley that Google, as it was called at the time, had a stealth division where moonshot projects were fostered. These days that subsidiary is simply called X and its purpose is to create a fertile ground for big technology bets that have the potential to revolutionize industries. Waymo was one such project, and it’s been estimated alone to have a value of $105 billion.
Another under-the-radar fact Ackman referenced is Alphabet’s chip manufacturing capability. While most investors think of Alphabet as a software firm, it has a line of hardware products too, including Google Home and Google Pixel phones. Hardware typically has a lower margin than software, so these devices offer a feeder for customers into higher margin software products that in turn provide Alphabet key data insights it can leverage and monetize.
A common assumption many investors fall victim to is that Alphabet has a dominant presence in the US but it features prominently globally too and has established partnerships with major global enterprises, such as Siemens. That provides Alphabet a strong footprint in far afield lands from its California headquarters, such as South Korea.
Circling back to artificial intelligence, Alphabet was the original artificial intelligence pioneer after snapping up most of the AI talent in the world following its acquisition of DeepMind. These days Alphabet leverages its expertise not only to create AI tools such as Bard but also to address real-world healthcare challenges, such as protein-folding.
Lastly, an underrated but invaluable asset Alphabet enjoys is access to top-tier talent. It’s notoriously difficult to secure a full-time role with Alphabet but those who do get in the doors typically stay according to data that shows Google has one of the lowest turnover rates among technology firms. That kind of operational stability is precisely the type of predictability that long-term investors like Ackman like to see.
When a world class investor like Ackman buys a top tier firm like Alphabet, it’s typically not for a single reason and that’s absolutely the case here.
Ackman bought Alphabet because of its wide economic moat, certainly. But that moat is multi-pronged and includes consistently growing revenues thanks to a diverse and growing product suite that includes Google Search, YouTube, Google Cloud, Google Maps, Gmail, Bard, and a host of other initiatives.
Will Ackman make money with his investment? Perhaps the answer is in the name of the company itself, Alphabet, which can be re-worded as alpha bet, and indeed that was reportedly a reason for the company’s name change, to signal to investors that an investment in the company would be a bet that would deliver alpha, or market-beating returns.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.