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Elite Hedge Funds Have This To Say About Alphabet Inc. (GOOG)

Alphabet Inc. (NASDAQ:GOOG) needs little or no introduction. The masses already know that Google officially became Alphabet, but what is the freshly-created company and why was it created in the first place? As Google’s co-founder Larry Page put it, Alphabet is simply a “collection of companies” that is set to enable its businesses to develop at a faster pace and “allow us to keep tremendous focus on the extraordinary opportunities” that the company has. Therefore, Google became a wholly-owned subsidiary of Alphabet. While Google will continue to oversee its core business that includes Android, Search, YouTube, Apps, Maps, and Ads, the companies that are “far afield” of its core business are now part of the broader Alphabet. These include Google Fiber (high-speed internet), its health-focused businesses such as Calico and Life Sciences, and Google X, to name just a few.

Meanwhile, Alphabet’s shares are extremely popular among the hedge funds monitored by Insider Monkey, be it the company’s Class A shares or Class C shares, which were maintained in the same fashion as the former Google’s were. There were 115 hedge funds invested in Alphabet’s Class A common stock at the end of the second quarter, compared to 121 registered in the prior one. Even so, the value of these positions increased to $8.19 billion from $7.36 billion during the June quarter. At the same time, 107 hedge funds within our database had Alphabet’s Class C common stock in their portfolios at the end of the June quarter, one less quarter-over-quarter. The overall value of these stakes increased to $8.59 billion from $6.88 billion during the three-month period. However, this article is not intended to discuss the new corporate structure of Alphabet, but rather, is aimed at discussing one of its investor’s thoughts on the stock.

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Asset management firm RV Capital, which categorizes itself as a value-oriented firm, discussed Alphabet Inc. (NASDAQ:GOOG) in a public letter to investors covering the second quarter. The investment firm, which is run by Robert Vinall, primarily targets undervalued companies that are “run by honest and talented managers”, so its comments on the tech giant might be quite worthwhile for an average investor. It is also worth pointing out that RV Capital’s comments are mainly related to the company’s financial performance and capital allocation. Let’s remind you that Google, or the freshly-named Alphabet (it might take a while until the masses will get used to the new name), generated revenues of $66 billion in 2014, which yields an increase of 19% year-over-year. Simultaneously, the company’s net income from continuing operations came to $13.93 billion, up from $13.35 billion reported a year ago.

RV Capital outlined in the letter that “the discontinuity between Google’s revenue and earnings growth is the main source of controversy amongst investors”, which has been in turn spurred by the “precipitous growth in all operating costs, in particular research”. The research and development spending added up to $6.08 billion in 2012, $7.14 billion in 2013, and $9.83 billion in 2014. Hence, “the controversy is whether such a high level makes sense”.

Most investors don’t understand hedge funds and indicators that are based on hedge funds’ activities. They ignore hedge funds because of their recent poor performance in the bull market. Our research indicates that hedge funds underperformed because they aren’t 100% long. Hedge fund fees are also very large compared to the returns generated and they reduce the net returns experienced by investors. We uncovered that hedge funds’ long positions actually outperformed the market. For instance the 15 most popular small-cap stocks among funds beat the S&P 500 Index by more than 53 percentage points since the end of August 2012. These stocks returned a cumulative of 102% vs. 48.7% gain for the S&P 500 Index (read the details). That’s why we believe investors should pay attention to what hedge funds are buying (rather than what their net returns are).

Let’s now move on to the second page where you will see on which camp of the controversy RV Capital resides.

RV Capital’s Robert Vinall asserts that a high majority of people tend to question Alphabet’s capital allocation. However, he believes that “its track record is virtually blemishfree. YouTube, Android, Chrome, and Maps are just a few of its home runs”. RV Capital also discusses the existing concerns about Alphabet’s expenditures on unbelievable projects, saying that “Larry Page often says that he does not understand Wall Street’s concern that Google will spend too much on moon shots. His concern is finding sufficient opportunities to avoid spending too little”. Furthermore, despite the fact that the investment firm believes that the shares of Alphabet can greatly benefit over a short-term spectrum from a potential share buyback program, it still believes that Larry Page and his team are doing the right thing by deploying capital into the bounty of ongoing projects.

Certainly, the freshly-restructured Alphabet Inc. (NASDAQ:GOOG) will give more room to the smaller and riskier businesses to develop their own personality or identity. At the same time, this move is likely to increase transparency, as the company’s management intends to implement segment reporting for its fourth quarter financial report. Market participants may also get the chance to track the costs of some of Alphabet’s projects, while the holding company would be able to spin-off some of its experimental businesses without too much fuss. In the meantime, Alphabet keeps buying more businesses. Just recently, the tech giant acquired Divshot, a startup for app developers, in an attempt to attract more programmers to its cloud computing platform. As a result, the team behind Divshot is set to join Firebase, which is Alphabet’s developer-focused app development platform. All in all, it appears that there is more upside for Alphabet’s shares and its business in general, so make sure that you keep a close eye on the tech company and its future developments.

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