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Microsoft vs Alphabet: You Won’t Believe This!

If you are looking for the best ideas for your portfolio you may want to consider some of Wedgewood Partners top stock picks. Wedgewood Partners, an investment management firm, is bullish on Alphabet Inc. (NASDAQ:GOOG) stock. In its Q4 2019 investor letter – you can download a copy here – the firm discussed its investment thesis on Alphabet Inc. (NASDAQ:GOOG) stock. Alphabet Inc. (NASDAQ:GOOG) is a technology company that specializes in Internet-related services and products. Unfortunately, the stock is down 3.1% since the Wedgewood Partners pitch in January 2020.

Wedgewood believes that Alphabet Inc. (NASDAQ:GOOG) has a massive potential to increase its sales and margins driven by YouTube advertising and share gains in Google Cloud Platform. Alphabet’s cloud storage competes with Microsoft’s (NASDAQ:MSFT) Azure and Amazon’s (NASDAQ:AMZN) AWS. Alphabet is outgrowing industry leaders in the cloud computing space.

For the quarter ended December 31st, 2019, Wedgewood Partners fund recorded a return of 9.57%, compared to 10.62% of  Russell 1000 Growth Index and 9.07% of S&P 500 Index. This brings its 2019 full-year return to 31.96%, compared to 36.39% of  Russell 1000 Growth Index and 31.49% of S&P 500 Index.

Let’s take a look at comments made by Wedgewood about Alphabet Inc. (NASDAQ:GOOG) in the letter.

“Alphabet’s core Google subsidiary continues to show accelerating growth, driven by YouTube advertising and share gains in Google Cloud Platform (GCP), with the latter competing against Microsoft Azure and Amazon’s AWS. In addition to continued revenue growth, we think Alphabet has ample room to improve both margins and capital allocation over the next several years and drive excess returns.

Over the years, we have seen Google change its search and advertising algorithms on a regular basis, and sometimes those changes can have a disproportionate impact on quarterly revenues, but they are usually temporary. After dropping to mid-teens growth in the first quarter of the year (from the mid-20’s during 2018), shares sold off and provided an attractive opportunity to add to positions, given Alphabet’s history of tweaking its Google model and the associated short-term effects. Since then, advertising revenue growth has accelerated and is back to nearly 20% growth. Importantly, Google’s owned and operated properties continue to exhibit healthy growth, which are higher margin revenues relative to its largely pass-through Network Member revenues. A key driver of Google property growth continues to be mobile search, as well as increased monetization of YouTube. IDC estimates that around 8 in 10 smartphones shipped globally are Android-based, which typically come preinstalled with Google search and/or Google’s mobile browser. As for Apple iOS devices (iPhones and iPads), we estimate Google’s traffic acquisition costs (TAC) for Apple device traffic has plateaued over the past year or so and expect the growth of this expense to be more in line with iOS device growth (we estimate mid-single digits) longer term and should represent an attractive opportunity for margin expansion. As for YouTube, Alphabet’s management considers it to be “TAC-free,” so continued strong growth in this Google property should help bolster ex-TAC revenue longer term, as well.

Earlier this year, Alphabet gave a bit of incremental disclosure about the size and growth of its GCP service, which provides cloud infrastructure as a service to developers and IT departments. We estimate that this platform is likely outgrowing industry leaders AWS and Microsoft Azure, albeit from a smaller revenue base. While the Company does not disclose its cloud profitability, we expect GCP to drive incremental profit-dollar growth as this business gets larger and utilization rates increase.

Alphabet also has a couple of return-enhancing capital allocation options at its disposal. First, Alphabet is sitting on a mountain of cash, around $120 billion, and should generate close to $25 billion in free cash flow during 2019. We expect the Company to double its free cash flow over the next couple years with just a modicum of capital expenditure discipline. Second, if Alphabet’s historical trend of few large acquisitions continues, we would expect the Company to buy back stock at what would be a very attractive forward free cash flow multiple, especially relative to drop-dead (i.e. negative) rates on debt issuance around the globe. Last, we think Alphabet’s “Other Bets,” which represents a gaggle of noncore, under-disclosed, money-torching projects that have very little bearing on Google’s business, could easily be wound down. We estimate this could save shareholders between $3 billion and $5 billion per year and could be used to reduce the Company’s share count or supplement M&A.”

Alphabet

In Q1 2020, the number of bullish hedge fund positions on Alphabet Inc. (NASDAQ:GOOG) stock decreased by about 1% from the previous quarter (see the chart here), so a number of other hedge fund managers don’t seem to agree with Alphabet’s growth potential. Our calculations showed that Alphabet Inc. (NASDAQ:GOOG) is ranked #5 among the 30 most popular stocks among hedge funds.

The top 10 stocks among hedge funds returned 185% since the end of 2014 and outperformed the S&P 500 Index ETFs by more than 109 percentage points. We know it sounds unbelievable. You have been dismissing our articles about top hedge fund stocks mostly because you were fed biased information by other media outlets about hedge funds’ poor performance. You could have doubled the size of your nest egg by investing in the top hedge fund stocks instead of dumb S&P 500 ETFs. Below you can watch our video about the top 5 hedge fund stocks right now. All of these stocks had positive returns in 2020.

Video: Top 5 Stocks Among Hedge Funds

At Insider Monkey we leave no stone unturned when looking for the next great investment idea. For example, 2020’s unprecedented market conditions provide us with the highest number of trading opportunities in a decade. So we are checking out stocks recommended/scorned by legendary Bill Miller. We interview hedge fund managers and ask them about their best ideas. If you want to find out the best healthcare stock to buy right now, you can watch our latest hedge fund manager interview here. We read hedge fund investor letters and listen to stock pitches at hedge fund conferences. Our best call in 2020 was shorting the market when the S&P 500 was trading at 3150 after realizing the coronavirus pandemic’s significance before most investors. You can subscribe to our free enewsletter below to receive our stories in your inbox:

Disclosure: None. This article is originally published at Insider Monkey.