Technology Alphabet Inc. (NYSE: GOOGL) Recommendation: …...Alphabet incorporated on October 2,...

Important disclosures appear on the last page of this report.

Analysts

Andrew Ritts [email protected] Austin Hassett [email protected]

Company Overview Alphabet incorporated on October 2, 2015. The company’s main segment of business is the well-known search engine Google. While advertising revenues make up a significant amount of Alphabet’s revenue, it has another segment, Other Bets. This division of Alphabet is devoted to developing new innovative technology and it does some with charities and other small ventures. Alphabet has shown significant and consistent growth over the past few years. Stock Performance Highlights 52 week High $1,063.62 52 week Low $743.59 Beta Value 1.14 Average Daily Volume 1.6 m Share Highlights Market Capitalization $717.82 b Shares Outstanding 2.98.26 m EPS (current) $28.18 P/E Ratio 30 Dividend Yield 0% Dividend Payout Ratio 0% Company Performance Highlights ROA 12.37% ROE 15.02% Sales $90,272 b Financial Ratios Current Ratio 6.29 Debt to Equity 16.99%

Current Price $1,044 Target Price $1145-1165

Alphabet Exhibits Growth Potential

• Environment: Given the economic, industry, and company conditions now and our outlook going forward we see Alphabet showing a promising upside. As technology continues to grow we see Alphabet adapting and continuing to thrive. • Valuation: We believe that our DCF/EP valuation model is the most accurate and should be used to value Alphabet fairly. This model gave us a partial year adjusted value of $1,274, showing Alphabet as a good investment opportunity. • Diversification: As of the moment Alphabet is heavily dependent on the revenue streams coming from advertising on Google. However, they are in the process of trying to diversify their revenue segment with their Other Bets division. At the moment Other Bets operates as a research division to try and develop new emerging technologies.

• Challenges: Alphabet is having to deal with advertisement-blockers. These are blocking potential revenue for Alphabet. They have to find a way to either get people to turn their advertisement-blockers off when they get on Google or find a way for their advertisements not be visible for these advertisement-blockers. One Year Stock Performance

Source: Yahoo Finance

Krause Fund Fall 2017

Technology

Alphabet Inc. (NYSE: GOOGL)

Recommendation: Buy November 10, 2017


Economic Outlook

U.S. Real Gross Domestic Product

Real Gross Domestic Product (GDP) is the measure of the market’s total economic output during a period after adjustments for price changes caused by inflation. Real GDP is an important industry indicator because it reflects the overall health of the economy. When the economy is flourishing consumer spending and consumption increases which results in increased company revenues. Specifically, when consumers are spending more, advertisers will increase their advertising effort and consumers will increase their searches. Together, these will correlate to increased revenue for Alphabet.

The chart below displays the real U.S. GDP growth from preceding quarters. Real GDP growth declined .1% from 2017 quarter two (Q2). The high Q3 real GDP growth is partially contributable to increased inventories caused by this year’s hurricanes. Inventories increased by $35.8 billion dollars which resulted in .73% increase in the Q3 GDP.

Source: Mataloni L. and Aversa J.

We believe GDP will grow 2.3% over the next six months and reach a steady rate of 2% for the next five years. During the next six months, the lasting effects of the hurricanes will wear off causing inventories and real GDP to decrease. We expect the GDP to continue growing due to strong consumer confidence, which is at a 17 year high. Consumer confidence index reflects consumers’ current attitudes toward likely business conditions and developments. However, we expect GPD growth to slow do to the increasing interest rates. When interest rates increase, the cost of capital increases. This increase causes the cost of financing and M&A to increase. Then, as M&A transactions and capital spending decrease, the economy will experience slow growth.

Exchange Rates: Exchange rates are the value of one country’s currency in comparison with other countries currency. Exchange rates are

an important economical factor for the technology industry because the S&P Dow Jones Indices estimated that U.S. information technology companies generated 57.78% of sales overseas in 2015.17 When technology companies report their revenue in the U.S. or transfer their cash to the U.S., they will be directly affected by the exchange rate. The chart below shows the five companies with the most amount of cash held overseas. Depending where these companies hold their cash, the exchange rates may cause significant losses or potential gains.

One measure of the value of the U.S. dollar is the U.S. Dollar Index (DXY). The DXY is a value relative to the six major trading partners of the U.S. Currently the DXY is valued at 94.39 which is a 7.65% decrease from one year ago to date. The DXY has ranged from 91.01 to 103.82 over the past 52 weeks. The DXY has grown since October, but recent news from the U.S. Senate suggesting delayed corporate tax cuts caused the DXY to drop .52 points on November 10th. However, with the continuing GDP growth and positive consumer spending and confidence, we believe the DXY will resume its growth over the next six months through 2021 between the ranges of 95-98.4 The chart below illustrates the change in the DXY over the past three years.

U.S. Dollar Index (DXY)

Source: Market Watch In 2016, Alphabet reported only 47% of revenues generated in the United States, 9% in the United Kingdom, and 44% in the rest of the world as displayed in the pie chart below.

Source: Meisler, L


Source: Alphabet Inc. This chart shows exchange rates play a big factor in Alphabets revenue, and this factor will continue to be important as Alphabet grows. Currently, the exchange rate of the US dollar to the British Pound is .75811. This rate is favorable for Alphabet. However, the British Pound unexpectedly weakened over the year which caused Alphabet’s expected revenues to decrease. Additionally, the other 44% of profits from the rest of the world were negatively impacted, because the US dollar strengthened in comparison to the Euro and Argentine peso. Employment: The unemployment rate is a measure of the percent of jobless individuals in the labor force. This rate is highly correlated to economic strength because a strong economy creates job growth, decreasing the unemployment rate. It is also valuable to consider the employment rate when analyzing changes in employment. The employment rate is a ratio measuring the number of employed individuals to the working age population (15 to 64). Together, these two rates are valuable to technology firms because they shadow economic strength and revenue growth. The technology industry requires highly educated individuals, which creates problems within the industry when companies are all competing for the same talented individuals. Alphabet noted that their skilled employees are one of several targets for competition, and several competitors have directly targeted their skilled employees. This competition for skilled employees and direct competition for Alphabet’s employees has created wage competition. Alphabet is forced to offer higher wages to attract new employees, and it is faced with providing increasing compensation to ensure current employees stay. This wage competition will continue to increase in the future as demand for highly skilled technology workers increases.

The October U.S. unemployment rate was recorded at 4.1%, a .1% decreases from Septembers recorded 4.0%. The unemployment rate has been decreasing since the 2009 when the unemployment rate was 10%, October’s unemployment rate being a 17 year low. The charts below show the monthly unemployment rate over the past four months and nine years.

Source: Trading Economics We predict unemployment rate to average 4.4% over the next six months as we expect the labor force to increase as strong economic conditions continue. Over the next five years, we expect unemployment to range from 4.4 to 4.8 percent. We believe the low unemployment rate will continue to make finding qualified workers more difficult for companies since there is only a small portion of the labor force seeking jobs. Capital Market Outlook: Overall, we believe the technology sector will continue to display strong growth. This is due to increasing real GDP, consumer confidence, consumer spending and low unemployment within the U.S. We do expect the US dollar to strengthen, which will cause potential revenue losses for the technology companies earning foreign revenue. However, the industry growth will increase revenues more than the exchange rates will devalue the foreign revenue.


Source: Statista The bar chart on the previous page illustrates adverting expenditure growth in emerging markets compared to the U.S. The driver of this growth is increasing economic development and increasing middle class. Together, these factors present large growth opportunities for the technology industry because foreign revenues will increase. We believe that with these economic forecasts, Alphabet and the technology sector will continue growing as it has demonstrated over the last five years.

Industry Analysis Industry Overview Alphabet is primarily in the advertising industry. However, it is also in the search engine industry to draw in its customers to its advertising. Some other companies in the type of industry are Baidu, Bing, and Yahoo. Firms in this industry make money on a paid-per-click basis. When someone clicks on an ad on these search engines, the company whose ad it is pays the search engine companies. Typically, they pay them a pre-specified amount for each time their ad is clicked on. Business Segments Alphabet’s two business segments are Google and Other Bets. Googling something has replaced the dictionary almost completely when it comes to looking up what something is or means. This ability to draw in potential customers whenever they are curious about something is Google’s biggest strength. Google has 3.5 billion searches a day, which gives them 3.5 billion opportunities for profit each day.10 As the world’s population continues to increase and more people gain access to the internet we only see this number growing in the future. Alphabets up and coming business segment is their Other Bets. Other Bets is a segment of Alphabet that focuses on side ventures help people or develop new product lines. The Other Bet divisions we see with the most potential in the future are Nest and X. Nest consists of smart home products. An example of this would be a smart thermostat that would turn

the air conditioning off in the summer when you leave for work and turn back on an hour before you get home so your home is cool only when you are there. Alphabet’s X division has Waymo, their self-driving car unit.2 Revenues Revenue streams in the search engine industry primarily consist of advertising revenue. Companies pay the search engine companies to have advertisements on all of their pages when anyone searches anything. Then the company pays the search engine company every time someone clicks on their advertisement. Typically, it is a fixed cost paid per click.

Source: Revenues and Profits The above pie chart that shows while the U.S. is the country that contributes the most to Alphabet’s revenue, the rest of the world makes up the majority of the revenue. This has led to Alphabet having a large stockpile of cash outside of the U.S. The U.S. having a high tax rate relative to most other countries has caused Alphabet to keep the cash in these foreign countries as to avoid taxes. We don’t foresee Alphabet bringing this cash into the U.S. unless there is a large drop in the federal tax rate. Porter’s 5 Forces

Threat of new entrance into the industry is high due to low barriers to entry. As seen to the below, funding is readily available for companies in the technology space, accounting for 42.2% of venture capital funding from software and IT services. Venture capital investment in Q2 of 2016 alone valued $8.74B. Even if these new companies don’t directly compete with Alphabet in the search engine industry at first, they could change the dynamic of their company and compete with them for advertising revenue. While the funding for companies is readily available, we feel most companies will be intimidated to try and compete with Alphabet.8


Source: Hallet, R. We don’t feel the threat of substitute for search engines is a large issue. This is because search engines are so quick and convenient for answering questions or research. However, we are a little worried about other companies that offer advertising services drawing in customers instead of Alphabet’s search engine drawing them in. For example, Facebook, which has 97% of its revenue coming from advertising. We expect that Alphabet and Facebook will have minimal competition, because they are able to share customers and don’t compete in the way they bring customers to view their advertising. Alphabet brings their customers in by providing them information, while Facebook brings in their customers with social media.5

Bargaining power of buyers is low in this industry. As seen below Alphabet has over ¾ of the searches done by search engines. If these buyers/companies wanting their advertisement to be seen by lots of people Google is obviously the best choice. This gives these companies little power in negotiating price. Even if a company would pay twice as much to Google as they would to a different company, their advertisement would be seen more than twice as much so it would be a good investment.1

Search Engine Desktop and Mobile Market Share

Source: Allen, R Bargaining power of suppliers in this industry is low. Search engine companies don’t need a lot of materials as they don’t

provide physically products. They only need materials to build their office space and datacenters. Search engine rivalry is not very competitive at the moment as Google has such control of the industry. However, looking forward, we see this competition ramping up. We believe that within the next 5 years Baidu, basically the Chinese version of Google, will make a strong push to enter the US market and try to compete with Google. As seen on the top right, Baidu has an extremely large share of the search engine market in China. We believe they will try and achieve this kind of dominance in the US. We think that the sheer size and market dominance Google will scare off most companies from trying to enter the search engine industry if they are not already in it.

Source: CIW Team Our application of Porter’s 5 Forces to Alphabet leads us to believe that they will have a prosperous future. Neither suppliers nor buyers have much power over Alphabet, which allows Alphabet to save money on supplies and charge premiums on services like advertising space. We see this combination leading to an increase of Alphabet’s profit margins of about 2% over the next five years. We don’t see the profit margins growing any larger, because we expect Alphabet to increase research and development expenses for their Other Bets segment. If some company like Baidu or some other search engine company made a strong push most companies will be intimidated to try and compete with Alphabet.8 Cost-per-Click Cost-per-click is the amount of money a company makes when someone clicks on an advertisement that is posted on their website. The company gets paid from the company whose advertisement it is. For example, Nike may have an advertisement on Google and if someone


clicks on that advertisement Nike will pay Google a dollar. We feel that more companies will start to adopt this cost-per-click system into their company’s revenue streams as the world becomes more digital. We believe companies will start to provide a service to draw customers in, like Google and Facebook, and then implement this cost-per-click system for advertising revenue. Advertisement-Blockers We don’t see advertisement-blockers to be a large issue in this industry. We see them more as a small nagging reoccurring issue. We think that companies like Alphabet will create an algorithm so that their advertisements aren’t recognized by the advertisement blocker. Then new advertisement-blockers will be created to account for the algorithm and then this process will repeat. If there is an advertisement-blocker that Alphabet can’t beat then we think that Alphabet will have a little box that comes up when you go onto Google that will say something like “please click allow advertisements to continue to Google.” However, if it does come to that then we see potential disgruntled people who try and switch to a different search engine. While we don’t see this happening it would be a huge issue Alphabet would have to resolve this issue as they are so reliant on advertising revenue from Google. Mobile Trend The world is continuing to become more mobile in the technology space. Computers used to be as big as rooms, but now they can fit in our pocket in the form of smartphones. As seen below, in 2015 mobile searches surpassed desktop searches for the first time. In 2016, 60% of Google searches were made from a mobile device.7 We expect less people to buy desktops in the future and only have mobile devices, because of their mobility and convenience of mobile devices. We see this trend benefitting companies like Alphabet, Facebook, and Apple. This mobile trend will benefit Alphabet and Apple because they have operating systems that are used in mobile devices. Therefore, this trend will help knock out competitors who don’t have products that go mobile. Facebook is also well positioned, because its app can be accessed on a mobile device. We think that as this trend continues Amazon will start to make a larger push for their mobile app. They have one, but it is not nearly as widely used as Facebook’s.

Source: Allen, R. Catalysts for Growth/Change A potential issue for the search engine industry is the cost to store all this information. At least every 2 years the digital world doubles in size.9 This is only going to happen even quicker as the population on Earth increases and more people gain access to the internet. We see this starting to become a large issue for technology companies in the near future. Also, every 5 years the storage capacity of computers increases tenfold.16 So, the large issue here is whether the storage capacity of computers and datacenters will be able to keep up with the growth of information in a cost-effective manner. If it becomes too expensive to store this information companies will have to decide what to do, either pay the high costs or just not store the data. We feel more companies will start investing in trying to find ways to store information cheaper, whether that be reducing costs of current ways to store data or developing new products/ways to store data. A catalyst for growth in the search engine industry is the increase of accessibility to it. For people to have access to search engines they need to have access to the internet. These companies need to try and get people in emerging markets like Africa, India, and Southeast Asia access to the internet so they are able to visit their sites and click on advertisements to add to their revenue. As of 2016 only 46.1% of the world’s population were internet users.20 These search engine companies can over double their customer base if they are able to get internet access to the entire world. Once most or all the developed world has access to the internet we feel these search engine companies will start to try to help other countries get internet access. We think that this is what Alphabet is trying to do with their Loon project. We do not think other search engines companies will try projects like Loon. We believe they will try other ideas and just reap the benefits of Loon giving internet access to more people by trying to entice them to their search engine.


Competitor Comparison Comparing Alphabet to other companies in the search engine industry is difficult, because most other search engines are a minority part of the company. For example, Microsoft owns Bing, where Bing only makes up a small percentage of their annual revenue. Baidu is the only company that, like Alphabet, a majority of its revenue comes from advertisements on their search engine. In Q3 online advertisement made up about 86% of Baidu’s revenue, similarly to Alphabet’s 88%. However, Baidu’s market capitalization of only 81.41B makes them too small to be a good comparison to Alphabet with a market capitalization of 717.41B.2/3 The only company we believe is a good comparison for Alphabet is Facebook. Even though they are not in the same industry, they both provide a service to attract customers to their advertisements and have a similar size. We think of them both as advertising companies and this is why we feel it is fair to compare their operating metrics.

Source: Alphabet Inc. and Facebook Inc. There are no significant differences between the ROE and ROA of the Facebook or Alphabet. However, a company having no debt the size of Facebook is very odd. Facebook was able to stockpile enough cash that it doesn’t need to take out a loan to do any of its projects. We also believe that Facebook is now a mature stock and is not pursuing any large ventures in the future and this is why we feel they won’t need to take out any loans in the future either. Alphabet is still pursuing other products in their Other Bets segment and this is why we believe Alphabet still takes on some debt even though it has a large cash pile as well. We see Alphabet’s debt ratio staying around 2% for the foreseeable future as they continue to increase funds in their Other Bets segment and have intentions to continue that. Facebook has done a better job controlling its cost of revenues, which are 13.7 of revenue, compared to the 38.95% of Alphabet. We believe this difference contributes to a large portion of the difference in the profit margins. However, we don’t believe it would be this far apart if Alphabet would not be pursuing its Other Bets segment. This segment takes a lot of research

and development expenses that lower Alphabets profit margin. We predict that this expense will only increase over time and that Alphabet’s profit margin will decrease slightly year over year until or if they have a breakthrough product or cancel the segment. Key Investment Positives or Negatives A key investment positive for the search engine industry is longevity. The internet is constantly expanding where and how it can be accessed. We believe this trend will continue until 100% of the world’s population will have internet access. We also see more and more electronic devices that are made to have access to the internet. This leads to having a larger customer base and them having more access to Alphabet’s services. An investment negative is that the cost-per-click has been dropping for Alphabet since Q4 of 2011. As this trend continues Alphabet’s profit margins will start to become thinner. However, we see Alphabet trying to combat this margin thinning by trying to make its Other Bets segment more profitable.

Source: Rosoff, M

Company Analysis General Information Alphabet, Inc. is a leading multinational holding company in the technology industry. Alphabet consists of two main segments: Google Inc. and Other Bets. In 1998, Larry Page (CEO) and Sergey Brin (Pres.) founded the company Google. On September 4, 1998 google became incorporated. On August 19, 2004, Google took its next big step and had its initial public offering. During August 2015 Google announced its


plans to rename itself Alphabet and become a holding company. The main revenue stream for Alphabet is through advertising within the Google segment. As shown in the chart below, Google Inc. is responsible for 99.1% of Alphabets revenue.

Source: Alphabet Inc.

The Google segment includes Google Search, Ads, YouTube, Gmail, and Google Play, Google Cloud, Android, and Chrome. Other Bets include Access, Calico, CapitalG, GV, Nest, Verily, Waymo, and X. While Google is the main revenue driver, Other Bets is focused on creating innovate technological advances to create future sustainable competitive advantages. Alphabet, Inc. is still in the growth life cycle stage. From 2012 to 2016, Alphabet earned a CAGR of 12.46%. The 2017 Q3 report stated that revenues grew 24% year over year. Alphabet has demonstrated its ability to grow and plan for a successful future. Products and Markets: Product Lines Alphabet has two business segments, which include Google and Other Bets. Google is the leading revenue driver for Alphabet while Other Bets explores innovate technologies in search of technological breakthroughs. Google is a free search engine that generates traffic from over 1 billion users monthly and 1.2 trillion searches per year worldwide. This traffic draws the attention of advertisers looking to advertise to the billions of Google users every day. Google uses its software to optimize the similarity between advertisements and searches to increase the probability on the ad being clicked. Advertisements on Google have an associated cost-per click that the advertiser is required to pay depending on the total number of clicks. Overall, in 2016 Google advertising contributed 71.3% of the Google Segment Revenues. Other Google properties which included apps, in-app purchases, Google Cloud, and hardware contributed for the other 28.7% of the Google Segment Revenues.

Other Bets is designed to focus on machine learning and artificial intelligence capabilities. One company in the Other Bets segment is Waymo, a company working toward creating self-driving cars. Another company in the Other Bets segment in Nest. Nest is a smart thermostat designed to make controlling home temperatures easier, more cost effective long term, and environmentally friendly. Together, these two companies demonstrate how Alphabet balances Other Bets with companies that require heavy investments and companies that generate sufficient revenues. Machine learning has helped Alphabet’s data centers become more efficient and helps with Alphabets Other Bets, like their self-driving car division¹. As machine learning intelligence grows and integrates with humans’ daily lives, the potential upside for machine learning is endless. While there is potential for a technological breakthrough, Alphabet has not shown any signals for a potential breakthrough in the foreseeable future, so Other Bets will continue to remain only a small fraction on company revenue. Analysis of Recent Earnings and Managerial Guidance For quarter three of 2017, Alphabet reported revenue of $27,772 million and earnings per share of $9.57 which was above consensus at $8.33. Quarter three revenue growth is contributable to increases in user activity and mobile searching. These increases caused a 57% increase in paid clicks year over year. However, the cost per click decreased 22%, which countered some revenue growth. Consensus for fiscal year end 2017 earnings per share is 32.15. We believe earnings per share will be 34.18. This conclusion was reached after forecasting continued growth in revenue. Revenue will continue to increase because more consumers are shifting to online which is causing the digital economy to grow, and an increasing number of consumers are using multiple devices creating an increase in access to Alphabet products and pay-per click advertisements¹. With the increasing shift to the digital economy, Alphabet can expect to see a continued growth in the amount of revenue generated through pay per click. Another factor impacting Alphabets earning is the increasing amount of international markets¹. This factor will continue to contribute to earnings growth for Alphabet because each year there will be an increase in the number of consumers exposed to the company's products and advertisements.


Alphabet’s hardware product sales are increasing, but Other Bets have not reported the same amount of earnings or growth. However, the Other Bets is still in the developmental state, so they have potential to increase future returns. Alphabet has invested heavily into research and development, increasing the investment by $1,666 million up to $13,948 million for 2016.2 Q2 2017 reported an increase in revenue of 21% and increase in operating margin of 16% from 1-year prior². Alphabet will continue to see earnings growth over the next five years. Additionally, if the research and development investment leads Other Bets into the development of a new innovative technology, Alphabet may experience earning growth larger than previous years. Cost Structure: The main costs associated with Alphabet are generated by the Google business segment because this segment produces the most business within the holding company. Third quarter reports sighted cost of revenues at 40.1%, a 1.8% increase from one year ago. The revenue Google earns from adverting is calculated by the Cost per Click (CPC) and is the average amount Google charges advertisers per user engagement. CPC is calculated by taking click driven revenues divided by total number of paid click.

The chart on the top of the next page demonstrated the changes in the total number of clicks and the CPC that advertisers pay year over year. While Alphabet is growing the number of clicks at a large rate, its revenues are not growing at the same rate because Google is facing increasing costs.

Source: Alphabet 10-K The increase in cost is driven by increased traffic acquisition costs (TAC). Traffic acquisition costs are the costs Google pays its network partners to display ads. Network partners shifted their contracts because the shift to mobile advertising has increased the searches channeled through paid access points. In alignment with managerial guidance, we believe

the TAC costs will continue to increase as digital advertisements continue to shift from desktop to mobile.

Source: Alphabet Inc. The pie chart above displays the revenue cost contributions for Q3 2017. The chart displays the TAC for each segment in comparison to its revenue generated for Q3 2017. TAC accounts for nearly 50% of alphabets revenue costs. Competition: Alphabet has been extremely successful, which inevitably has drawn competition. Alphabet remains the leader in internet service sector and only faces minimal competition from companies within the sector including Bing, Baidu and Yahoo. However, because Alphabet’s main revenue stream is from advertising primarily, it faces critical competition from companies within different sectors that utilize their platform to generate advertising revenue. To accurately analyze the competitive environment facing Alphabet, it is critical to compare Alphabet with the competitors in its sector and competitors like Twitter, Facebook, Amazon, and Microsoft from other sectors. Catalysts for Growth/Change Alphabet’s opportunity for large growth or change will likely come from their Other Bets segment. Most likely to make this breakthrough would be Waymo, their self-driving car division. Currently, Waymo is being tested in four cities¹. If Alphabet is the first company to produce a fully functional and safe self-driving car their growth could increase drastically. Waymo could also change the type of company Alphabet is. If Waymo becomes successful Alphabet may try and enter the automotive industry. Alphabet’s leaders said they like high risk, high reward type projects¹. With this type of mentality, it should only be a matter of time before Alphabet has another massive product like Google.


Positives Alphabet reported $79,383 million in revenue from Google advertising during 2016. Google advertising is the initial driver for Alphabet’s success and is continuing to dominate that market. The chart below shows mobile search engine market share. Google, holds an unprecedented 94.06% as of October 2017. The revenues and market share held by Google in this field provides Alphabet with a strong backbone of cash needed to continue growing.

Search Engine Mobile Market Share⁵

In Q3 2017 Alphabet’s sales grew by 22% (year on year). Additionally, their net margins came to an average of 19.5% in the trailing year. Alphabet’s size and global power make it extremely low risk compared to almost all technology companies. They have a low percentage of debt and interest compared to their industry with a debt/equity ratio of 0.03. Alphabet also has capital to continue growing reporting a free cash flow margin of 17.6% and operating cash flow equal to 2.1 times their net income³. Considering these factors, Alphabet is positioned for a strong future. Negatives Alphabet acknowledges in their 10-K that there is competition amongst them, and their revenue growth has potential to be negatively affected if they slow down innovation or their ability to provide useful products¹. This threat causes Alphabet to invest more heavily into research and development to continue innovation above their competitors. Competition from social media companies and Amazon raises risk for potential lost revenue. Social media companies have the ability to increase their share of mobile advertising, which would cause Google mobile advertising revenues to decrease. Also, companies like Amazon intervene with potential advertisement engagement. Amazons simplistic shopping platform allow users to find the products and items they need without using search engines. As more consumers

shift to shopping on site like Amazon, Google will see decreases in the number of advertisement clicks. Over 70% of Alphabets revenues come from advertising. This is the biggest investment risk for Alphabet. If the economy enters a recession, spending by advertisers will decrease and the number of users’ advertisement engagements will decrease. These effects raise concerns as the end result would be large revenue deceases.

Valuation Analysis Revenue Decomposition Alphabets revenue is generated by Google segments and Other Bets. To further decompose revenue growth, we have broken Google Segments into revenue by Google Properties, Google Network Members’ Properties, and Google other Revenue.

The charts above illustrate the forecasted revenue and revenue growth per year. Alphabet does not give guidance on future earnings, so this forecast evaluation is based on past performance and heavily considers economic and industry trends.

Source: Net Market Share


Google Properties Google Properties accounted for 71% and 73% of revenue in the forecasted years 2017 and 2021 respectively. Google property revenue is driven by paid clicks and cost per clicks. We projected Google paid clicks to continue growing as consumers increase their exposure to advisements on YouTube and mobile devices. However, we expect paid click growth to slow from 48% in 2017 to 6% in 2021 because the shift to mobile advertising is increasing rapidly, which means future growth opportunities are being consumed. Google Network Members’ Properties Google Network Members’ Properties revenue contributed 13% of revenue during the forecasted period. Alphabets Q3 report stated this segment growth at 10% caused by increased mobile advertising exposure. We forecast this segment’s revenue to continue. However, we do not expect Alphabet to increase the number of network members because the profit margin on this segment is heavily diminished by traffic acquisition costs. Google Other Revenues Google Other Revenues is forecasted to contribute 13% to total revenue over the forecasted period. Revenue growth in this segment is driven by in-app purchases, Google Cloud, and hardware sales. We forecast this segment to grow 31% in 2017 driven by increased consumer spending and increasing number of mobile users. We expect the revenue growth continue, but slow as labor costs increase and the number of non-Google Cloud users decreases. Other Bets Other Bets revenue accounts for 1% of total revenue. The nature of this segment creates revenue volatility and difficulty predicting future growth given Alphabet has not released any guidance. Given that Alphabet has not had any breakthroughs within this segment in the past, we have decided to keep this revenue growth conservative and avoid accounting for breakthroughs. We expect this segment to continue to grow at 42% in 2017 and 20% in 2021 as Nest increases it revenue growth and profit margins. Operating Expenses Cost of Goods Sold Alphabets reports cost of revenues net cost of goods sold, depreciation expense, and amortization expense. To increase the transparency of this forecast, we have separated depreciation and amortization expenses from cost of revenues to show actual cost of goods sold. This allowed us to forecast depreciation and amortization as a percent of PPE and intangible assets in alignment with the company’s depreciation and amortization rates. From 2014 through 2016, Alphabet reported COGS as 31.4% of revenue.

However, we believe the increasing wage competition and increasing TAC will cause cost of goods sold to increase. We expect cost of goods sold increase 3% making 2021 cost of goods sold 35% of revenue. Research and Development Alphabet is a leading technology company, and to remain a leader in this industry Alphabet is forced to invest heavily into research and development (R&D). During the last five years, Alphabet has invested 14.7% of revenues back into R&D. As competition increases, Alphabet will need to look toward developing newer technologies to sustain its current market share. Therefore, we expect Alphabet to increase its R&D investment. Alphabets R&D will increase a large part by the increase in revenue, but we believe alphabet will increase R&D to 16.5% of revenues by 2021. Selling and Marketing Expenses Selling and marketing expenses (S&M) are the selling and marketing department labor and advertising expenses for Alphabets products and services. Since 2012, S&A has increased from $6,143 to $10,485. While the total S&A increased, S&M as a percent of sales decrease from 12.2% to 11.6%. We expect labor prices to increase as talent acquisition and retention become more competitive. We also expect advertising expenses to increase over the next five years as competition for market share increases. These factors led us expect S&M to increase over the next five years. However, we kept S&M as a percentage of sales at 11.5% because this rate combined with revenue growth will lead S&M to increase over $8,000 by 2021. General and Administrative Expense General and administrative expenses (G&A) are comprised of labor costs and service fees. As with S&M, we expect labor costs to increase, so we forecasted G&A to increase from $6,985 in 2016 to $11,675 in 2021. While S&M is increasing, we forecasted S&M as a percentage of sales to have a slight decrease in year 2019. We believe the impact of increasing revenues will over compensate for the decrease and provide the appropriate amount of S&M to operate efficiently. WACC The weighted average cost of capital (WACC) calculation is heavily weighted on the cost of equity, because Alphabet maintains minimal debt. Alphabet can do this, because they have managed to develop a large cash reserve.


Cost of Equity To calculate the cost of equity we took the risk free rate of return times the equity risk premium and then added that to Beta. The risk free rate of return we used for the WACC calculation was the 30 year Treasury bond rate as of November 10, 2017, which was 2.9%. The equity risk premium we chose to use was a geometric average risk premium from 1928-2016 of the S&P, which was 4.65%. We chose to use the S&P, because it has a diverse portfolio of stocks that are a good proxy for the market as a whole. Also, the S&P has been around since 1957 and gives a large data set. We chose to use a geometric average over arithmetic average, because the geometric average considers compounding returns, whereas the arithmetic average does not. We arrived at our Beta value of 1.141 by calculating the average of the 2, 3, 4, and 5 monthly and weekly average raw Betas. To get our cost of equity of 8.22%, we multiplied the market equity risk premium by Beta and then added the risk free rate. Cost of Debt To calculate the after tax cost of debt we took the pre-tax cost of debt multiplied by (1-marginal tax rate). For the pre-tax cost of debt we used the return on a 30 year corporate bond. Alphabet did not have any long term bonds so we used another company that shared the same AA+ Moody’s debt rating. We decided to use a 30 year corporate bond for Apple. We chose Apple, because they had the same bond rating of AA+, and they are a technology company of similar size and cash reserves. The return for the 30 year corporate bond for Apple was 3.85%. To calculate the marginal tax rate we took the US federal tax rate subtracted the foreign rate differential and the federal research credit Alphabet received. For this we did 35%-11%-2%=22%. To calculate the after tax cost of debt we did 3.85 %*( 1-22%) to get 3%. Weights To calculate the weights of equity and debt, we calculated the total value of equity and debt. We calculate the weight of equity by multiplying the total shares outstanding by the current share price and arrived at the value of $723,470. To get the value of debt we added the long term debt listed on the 10-K to the present value of operating leases to get $10,477.58. We then added these two values up and divided their respective values by their totals to get their weights. To get this we did 723,470.12/733,947.69 to get 98.57% for equity and 10,477.58/733,947.69 to get 1.43% for debt. We see these weights staying at the relative percentages in the future. We do not predict that Alphabet will take on much debt going forward as they don’t need to with their large cash reserves. Therefore, to calculate our WACC we took the weight of debt and equity multiplied by their respective costs and added them together to get our value of 8.15%.

Relative Valuation Models The proxy industry average P/E ratio is 25.5. However, Alphabet is trading at an industry premium of 30 P/E. We believe Alphabet should trade at a premium because it has 77.43% of the market share. This market dominance makes Alphabet a very attractive investment. Our relative valuation gives Alphabet a price of $520.82-$888.33. We put low emphasis on this price range because Alphabet does not have many competitors with similar operating structures. For example it is a very large technology company and there are only five other technology companies similar in size. Also, Alphabets revenues are primarily from advertising, and the only company similar to Alphabet’s size and revenue source is Facebook. Alphabet has a 2018 PEG ratio of 3.1, which is above the proxy industry average of 1.8. The outlier Baidu has a large influence on the average PEG because it is five points above the average. We decided to exclude Baidu from the PEG ratio to keep the average more consistent. Alphabet is justified to be trading at a premium seen by the higher PEG ratio for the same reasons it trades at a premium of P/E. We do not put much weight in this value because Alphabet does not have a good set of companies to be compare multiples with. Dividend Discount Model (DDM) We don’t feel that the DDM is a good model for Alphabet because they are a non-dividend paying company. The core of the model is based on dividends so we had to use an alternative form to get this model to work. Additionally Alphabet has said they have no plans to pay dividends in the future. To get the value of equity for this model we used P/E times EPS of the CV year to get $706. We then made a partial year adjustment to $736. DCF and EP Model We believe that the DCF/EP model is the best way to find the intrinsic value of Alphabet’s stock. This method gives us a stock price after partial year adjustments of $1,166. We like this method best because it incorporates all income statement and balance sheet factors. This model also takes in account different costs/debts and non-operating assets the company may have into its intrinsic value. We believe this high value is due to forecasted revenue growth above 10% until the CV year. This growth is forecasted high because we see Alphabet’ sales increase as people, particularly in emerging


markets, are able to gain access to the internet and be able to click on their advertisements. Sensitivity Analysis Beta vs Equity Risk Premium Beta and equity risk premium are important variable for calculating the cost of equity. The cost of equity is critical to Alphabet because over 98% of their WACC weight is made up from equity fund. We have selected the range of $1,556 to $929 as the range of potential values. WACC vs CV Growth of NOPLAT This analysis shows us that relative to each other the change in CV growth of NOPLAT has a large effect on the Alphabet’s stock price than fluctuations in WACC. We don’t see Alphabet’s WACC change much in the future because we don’t see them having any large capital structure changes. These two factors have an inverse relationship in terms of how they affect the stock price. Therefore, Alphabet would want to minimize their WACC and increase CV NOPLAT growth simultaneously ideally. Beta vs CV Growth of NOPLAT Given this analysis we would recommend Alphabet focusing more on increasing NOPLAT CV growth as it has a larger effect on the stock price. Also, it is more difficult to control a company’s Beta, because you are unable to control the volatility of the market. Beta vs Risk Free Rate Both of these factors had extremely similar effects on the stock price. As either or both of these factors dropped the stock price increased. However, in the future we see the risk free rate increase soon, which would cause the price of Alphabet stock to decrease holding Beta constant.


References

1. Alphabet Inc. (2017 February 3). Alphabet Form 10-K. Retrieved from https://www.sec.gov/Archives/edgar/data/1652 044/000165204417000008/goog10kq42016.htm.

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Retrieved from http://media.corporateir.net/media_files/IROL/18/188488/Baidu%202 016%2020F.pdf.

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10-K. Retrieved from https://www.sec.gov/Archives/edgar/data/1326 801/000132680116000043/fb12312015x10k.htm.

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Industries Attracting the Most Venture Capital. Retrieved from ttps://www.weforum.org/agenda/2017/02/theseare-the-industries-attracting-the-most-venturecapital/.

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Exponential Growth of Data. Retrieved from https://insidebigdata.com/2017/02/16/theexponential-growth-of-data/.

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Stashes of Cash Companies Keep Overseas. Retrieved fromhttps://www.bloomberg.com/graphics/2017overseas-profits/.

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Technological Progress. Retrieved from https://ourworldindata.org/technological-progress/.

16. Rosoff, M. (2015 October 23). Google's Average Ad Rates Just Keep Falling, but Wall Street No Longer Seems to Care. Retrieved from http://www.businessinsider.com/googlecpc-change-over-time-2015-10.

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Important Disclaimer This report was created by students enrolled in the Security Analysis (6F:112) class at the University of Iowa. The report was originally created to offer an internal investment recommendation for the University of Iowa Krause Fund and its advisory board. The report also provides potential employers and other interested parties an example of the students’ skills, knowledge and abilities. Members of the Krause Fund are not registered investment advisors, brokers or officially licensed financial professionals. The investment advice contained in this report does not represent an offer or solicitation to buy or sell any of the securities mentioned. Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a complete compilation of data, and its accuracy is not guaranteed. From time to time, the University of Iowa, its faculty, staff, students, or the Krause Fund may hold a financial interest in the companies mentioned in this report.

Ticker Symbol GOOGLCurrent Share Price $1,044.15Current Model Date 11/10/2017FY End (month/day) Dec. 31Cost of Equity 8.22%CV ROIC 53.22%Pre-Tax Cost of Debt 3.85%Beta 1.141Risk-Free Rate (30 Yr US Treasury) 2.918%Equity Risk Premium 4.65%CV Growth of NOPLAT 4.30%CV Growth of EPSCurrent Dividend Yield 0.00%Marginal Tax Rate 22.00%DCF / EP Intrinsic Value 1,166$ Effective Tax Rate 19.00%WACC 8.15%10-year Treasury bond 2.34%Inflation 2.23%

Alphabet Inc.Key Assumptions of Valuation Model

WACC Equity Risk Premium1,165.95$ 7.60% 7.75% 7.90% 8.15% 8.20% 8.35% 8.50% 1,165.95$ 4.05% 4.25% 4.45% 4.65% 4.85% 5.05% 5.25%

3.60% 1,161$ 1,122$ 1,085$ 1,030$ 1,018$ 988$ 960$ 2.218% 1,749$ 1,612$ 1,497$ 1,397$ 1,312$ 1,236$ 1,170$ 3.70% 1,184$ 1,142$ 1,104$ 1,047$ 1,035$ 1,004$ 974$ 2.318% 1,686$ 1,559$ 1,451$ 1,358$ 1,277$ 1,206$ 1,144$ 3.80% 1,207$ 1,164$ 1,124$ 1,064$ 1,052$ 1,019$ 989$ 2.418% 1,628$ 1,510$ 1,409$ 1,322$ 1,245$ 1,178$ 1,118$ 3.90% 1,232$ 1,187$ 1,145$ 1,083$ 1,070$ 1,036$ 1,005$ 2.518% 1,574$ 1,464$ 1,369$ 1,287$ 1,215$ 1,151$ 1,094$ 4.00% 1,259$ 1,211$ 1,167$ 1,102$ 1,089$ 1,053$ 1,021$ 2.618% 1,523$ 1,421$ 1,332$ 1,254$ 1,186$ 1,125$ 1,071$ 4.10% 1,286$ 1,236$ 1,190$ 1,122$ 1,108$ 1,072$ 1,038$ 2.718% 1,476$ 1,380$ 1,296$ 1,223$ 1,158$ 1,101$ 1,049$ 4.20% 1,316$ 1,263$ 1,215$ 1,144$ 1,129$ 1,091$ 1,055$ 2.818% 1,433$ 1,342$ 1,263$ 1,194$ 1,132$ 1,077$ 1,028$ 4.30% 1,347$ 1,291$ 1,241$ 1,166$ 1,151$ 1,111$ 1,074$ 2.918% 1,391$ 1,306$ 1,232$ 1,166$ 1,108$ 1,055$ 1,008$ 4.40% 1,380$ 1,321$ 1,268$ 1,190$ 1,173$ 1,132$ 1,093$ 3.018% 1,353$ 1,272$ 1,202$ 1,140$ 1,084$ 1,034$ 989$ 4.50% 1,415$ 1,353$ 1,297$ 1,215$ 1,198$ 1,154$ 1,113$ 3.118% 1,316$ 1,240$ 1,174$ 1,114$ 1,061$ 1,014$ 971$ 4.60% 1,453$ 1,387$ 1,327$ 1,241$ 1,223$ 1,177$ 1,135$ 3.218% 1,282$ 1,210$ 1,147$ 1,090$ 1,040$ 994$ 953$ 4.70% 1,493$ 1,423$ 1,360$ 1,268$ 1,250$ 1,201$ 1,157$ 3.318% 1,249$ 1,181$ 1,121$ 1,068$ 1,019$ 976$ 936$ 4.80% 1,536$ 1,462$ 1,395$ 1,298$ 1,278$ 1,227$ 1,181$ 3.418% 1,219$ 1,154$ 1,097$ 1,046$ 1,000$ 958$ 920$ 4.90% 1,582$ 1,503$ 1,431$ 1,329$ 1,308$ 1,255$ 1,206$ 3.518% 1,189$ 1,128$ 1,074$ 1,025$ 981$ 941$ 904$

CV Growth of ROIC Beta1,165.95$ 0.99 1.04 1.09 1.14 1.19 1.24 1.29 1,165.95$ 0.99 1.04 1.09 1.14 1.19 1.24 1.29

3.15% 2,515$ 2,312$ 2,141$ 1,995$ 1,868$ 1,757$ 1,659$ 3.70% 1,218$ 1,154$ 1,097$ 1,047$ 1,000$ 958$ 920$ 3.40% 2,211$ 2,043$ 1,900$ 1,777$ 1,669$ 1,575$ 1,491$ 3.80% 1,243$ 1,176$ 1,117$ 1,065$ 1,015$ 972$ 933$ 3.65% 1,975$ 1,832$ 1,710$ 1,604$ 1,511$ 1,429$ 1,356$ 3.90% 1,270$ 1,200$ 1,137$ 1,083$ 1,032$ 987$ 946$ 3.90% 1,786$ 1,663$ 1,556$ 1,464$ 1,382$ 1,309$ 1,245$ 4.00% 1,299$ 1,225$ 1,159$ 1,102$ 1,049$ 1,002$ 960$ 4.15% 1,633$ 1,524$ 1,430$ 1,347$ 1,275$ 1,210$ 1,152$ 4.10% 1,329$ 1,251$ 1,182$ 1,123$ 1,067$ 1,018$ 974$ 4.40% 1,505$ 1,408$ 1,323$ 1,249$ 1,184$ 1,126$ 1,073$ 4.20% 1,361$ 1,279$ 1,206$ 1,144$ 1,086$ 1,035$ 989$ 4.65% 1,396$ 1,309$ 1,233$ 1,166$ 1,106$ 1,053$ 1,006$ 4.30% 1,395$ 1,308$ 1,232$ 1,166$ 1,106$ 1,053$ 1,005$ 4.90% 1,304$ 1,225$ 1,155$ 1,094$ 1,039$ 991$ 947$ 4.40% 1,431$ 1,339$ 1,259$ 1,190$ 1,126$ 1,071$ 1,021$ 5.15% 1,224$ 1,151$ 1,087$ 1,031$ 981$ 936$ 895$ 4.50% 1,470$ 1,372$ 1,287$ 1,215$ 1,148$ 1,090$ 1,038$ 5.40% 1,154$ 1,087$ 1,028$ 976$ 929$ 888$ 850$ 4.60% 1,511$ 1,407$ 1,317$ 1,241$ 1,171$ 1,110$ 1,056$ 5.65% 1,092$ 1,030$ 975$ 927$ 884$ 845$ 810$ 4.70% 1,555$ 1,444$ 1,349$ 1,269$ 1,195$ 1,131$ 1,075$ 5.90% 1,037$ 979$ 928$ 883$ 843$ 806$ 773$ 4.80% 1,603$ 1,484$ 1,383$ 1,298$ 1,220$ 1,154$ 1,095$ 6.15% 988$ 934$ 886$ 844$ 806$ 772$ 741$ 4.90% 1,654$ 1,527$ 1,420$ 1,329$ 1,247$ 1,177$ 1,115$

CV Growth of NOPLAT

CV Growth of NOPLAT

Equity Risk Premium

Risk Free Rate

Alphabet Inc.Revenue Decompositionin MillionsFiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021CV

Google Segments:Google Properties 45,085 52,357 63,785 77,818 93,381 110,190 124,515 131,363

YoY % Change 20.5% 16.1% 21.8% 22.0% 20.0% 18.0% 13.0% 5.5%

Google Network Members' Properties 14,539 15,033 15,598 17,158 18,359 19,277 19,759 20,154 YoY % Change 6.5% 3.4% 3.8% 10.0% 7.0% 5.0% 2.5% 2.0%

Google Advertising 59,624 67,390 79,383 94,976 111,740 129,467 144,273 151,517 YoY % Change 16.7% 13.0% 17.8% 19.6% 17.7% 15.9% 11.4% 5.0%

Google Other Revenue 6,050 7,154 10,080 13,205 16,374 20,304 24,364 26,801 YoY % Change 36.4% 18.2% 40.9% 31.0% 24.0% 24.0% 20.0% 10.0%

Google Segment Revenues 65,674 74,544 89,463 108,180 128,114 149,770 168,638 178,318 YoY % Change 18.3% 13.5% 20.0% 20.9% 18.4% 16.9% 12.6% 5.7%

Other BetsOther Bets Revenue 327 445 809 1,149 1,493 1,807 2,168 2,602

YoY % Change 2625.0% 36.1% 81.8% 42.0% 30.0% 21.0% 20.0% 20.0%

Total Revenue 66,001 74,989 90,272 109,329 129,607 151,577 170,806 180,920 YoY % Change 18.9% 13.6% 20.4% 21.1% 18.5% 17.0% 12.7% 5.9%

Aggregate paid clicks change 20.0% 22.0% 32.0% 48.0% 40.0% 29.0% 12.0% 6.0%Aggregate cost-per-click change -6.0% -11.0% -11.0% -15.0% -10.0% -8.0% 4.0% 4.0%

Alphabet Inc.Income Statementin MillionsFiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021CVRevenues:

Sales 66,001$ 74,989$ 90,272$ $ 109,329 $ 129,607 $ 151,577 $ 170,806 $ 180,920 Depreciation & amortization of property & equipment 3,523 4,132 5,267 6,479 7,373 8,145 8,819 9,416 Amortization & impairment of intangible assets 1,456 931 877 682 541 430 341 271 Cost of revenue 20,712 23,101 28,994 36,079 44,067 53,052 59,782 63,322

Gross Profit 40,310 46,825 55,134 66,090 77,627 89,951 101,864 107,912 Expenses:

Research & development expenses 9,832 12,282 13,948 16,946 20,089 24,252 27,329 29,852 Sales & marketing expenses 8,131 9,047 10,485 12,573 15,553 18,947 21,351 23,520 General & administrative expenses 5,851 6,136 6,985 7,653 9,073 9,853 11,102 11,760

Total costs & expenses 23,814 27,465 31,418 37,172 44,715 53,052 59,782 65,131 Income from operations 16,496 19,360 23,716 28,918 32,912 36,899 42,081 42,780

Other Income (Expenses)Realized gains on available-for-sale investments, net 153 - - - - - - - Foreign currency exchange gains (losses), net (402) (422) (475) (442) (442) (442) (442) (442) Gain (loss) on marketable securities, net - (208) (210) (209) (209) (209) (209) (209) Realized gain on equity interest 126 - - - - - - - Gain (loss) on non-marketable investments, net 159 (126) (65) - - - - - Gain (loss) on diverstiture of businesses - - - - - - - - Interest & other income, net 763 291 434 547 648 758 854 905

Income before income taxes 17,259 19,651 24,150 29,465 33,560 37,656 42,935 43,685 Provision for income taxes 3,639 3,303 4,672 5,444 6,201 6,958 7,934 8,072 Net income from continuing operations 13,620 16,348 19,478 24,020 27,359 30,698 35,002 35,613 Net income (loss) from discontinued operations 516 - - - - - - -

Net income 14,136$ 16,348$ 19,478$ 24,020$ 27,359$ 30,698$ 35,002$ 35,613$

Basic EPS 20.78$ 23.78$ 28.18$ 34.84$ 39.86$ 44.91$ 51.41$ 52.49$ Dividends/share - - - - - - - - Total Shares Outstanding 680 687 693 690 686 684 681 678

Alphabet Inc.Balance Sheetin MillionsFiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021CVAssets:Current Assets:

Cash and Cash Equivalents $ 18,347 $ 16,549 $ 12,918 $ 11,204 $ 18,978 $ 27,556 $ 38,923 $ 49,573 Marketable Securities 46,048 56,517 73,415 88,773 101,516 117,131 134,719 154,359 Total cash, cash equivalents, & marketable securities 64,395 73,066 86,333 99,978 120,495 144,687 173,643 203,932 Accounts receivable, net allowance 9,383 11,556 14,137 16,436 19,484 22,787 25,678 27,198 Receivable under reverse repurchase agreements 875 450 - - - - - - Deferred income taxes, net 1,322 - - - - - - - Income taxes receivable, net 1,298 1,903 95 460 471 481 492 503 Inventories - - 268 274 274 274 285 284 Prepaid revenue share, expenses & other assets 3,412 3,139 4,575 5,116 6,065 7,093 7,993 8,466

Total current assets 80,685 90,114 105,408 122,264 146,789 175,323 208,090 240,384 Prepaid revenue share, expenses & other assets, non-current 3,280 3,181 1,819 4,053 4,805 5,620 6,333 6,708 Non-marketable investments 3,079 5,183 5,878 7,171 7,817 8,520 9,287 10,123 Deferred income taxes - 251 383 - - - - - Property & equipment, net 23,883 29,016 34,234 38,959 43,039 46,603 49,753 52,574 Intangible assets, net 4,607 3,847 3,307 2,625 2,083 1,654 1,313 1,042 Goodwill 15,599 15,869 16,468 16,468 16,468 16,468 16,468 16,468

Total assets 131,133 147,461 167,497 191,540 221,001 254,187 291,244 327,298 Liabilities and Stockholders' EquityCurrent Liabilities:

Accounts payable 1,715$ 1,931$ 2,041$ 2,709$ 3,212$ 3,756$ 4,233$ 4,483$ Short-term debt 2,009 3,225 - - - - - - Accrued compensation & benefits 3,069 3,539 3,976 4,045 4,925 5,760 6,491 7,056 Accrued expenses & other current liabilities 4,434 4,768 6,144 7,140 8,464 9,899 11,154 11,815 Accrued revenue share 1,952 2,329 2,942 3,311 3,926 4,591 5,173 5,480 Securities lending payable 2,778 2,428 - - - - - - Deferred revenue 752 788 1,099 1,242 1,472 1,722 1,940 2,055 Income taxes payable, net 96 302 554 369 421 472 538 548

Total current liabilities 16,805 19,310 16,756 18,817 22,420 26,200 29,530 31,437 Long-term debt 3,228 1,995 3,935 3,971 4,541 5,240 6,027 6,905 Deferred revenue, non-current 104 151 202 222 263 308 347 367 Income taxes payable, net, non-current 3,407 3,663 4,677 5,440 6,240 7,065 7,906 8,752 Deferred income taxes 1,971 189 226 316 316 316 316 316 Other long-term liabilities 1,118 1,822 2,665 3,228 3,826 4,475 5,043 5,341

Total liabilities 26,633 27,130 28,461 31,994 37,606 43,603 49,167 53,118 Shareholders' equity:

Class A & class B common stock & class C capital stock additional paid- 28,767 32,982 36,307 32,797 29,288 25,778 22,268 18,759 Accumulated other comprehensive income (loss) 27 (1,874) (2,402) (2,402) (2,402) (2,402) (2,402) (2,402) Retained earnings 75,706 89,223 105,131 129,151 156,510 187,208 222,210 257,823

Total stockholders' equity 104,500 120,331 139,036 159,546 183,396 210,584 242,077 274,180 Total liabilities and shareholders' equity 131,133$ 147,461$ 167,497$ 191,540$ 221,001$ 254,187$ 291,244$ 327,298$

Alphabet Inc.Cash Flow Statementin MillionsFiscal Years Ending Dec. 31 2014 2015 2016Operating activities:

Net income (loss) 14,444$ 16,348$ 19,478$ Adjustments:Depreciation & amortization of property & equipment 3,523$ 4,132$ 5,267$ Amortization & impairment of intangible assets 1,456$ 931$ 877$ Stock-based compensation expense 4,279$ 5,203$ 6,703$ Excess tax benefits from stock-based award activities (648)$ (548)$ -Deferred income taxes (104)$ (179)$ (38)$ (Gain) loss on marketable & non-marketable investments, net (1,025)$ 155$ 237$ Other adjustments 87$ 212$ 174$

Changes in assets and liabilities, net effects of acquisitions:Accounts receivable (1,641)$ (2,094)$ (2,578)$ Income taxes, net 283$ (179)$ 3,125$ Inventories - - -Prepaid revenue share, expenses & other assets 459$ (318)$ 312$ Accounts payable 436$ 203$ 110$ Accrued expenses & other liabilities 757$ 1,597$ 1,515$ Accrued revenue share 245$ 339$ 593$ Deferred revenue (175)$ 43$ 223$

Net cash flows from operating activities 22,376$ 26,024$ 36,036$ Investing activities:

Purchases of property & equipment (10,959)$ (9,915)$ (10,212)$ Proceeds from disposals of property & equipment - - 240$ Purchases of marketable securities (56,310)$ (74,368)$ (84,509)$ Maturities & sales of marketable securities 51,315$ 62,905$ 66,895$

(4,995)$ (11,463)$ (17,614)$ Purchases of non-marketable investments (1,227)$ (2,172)$ (1,109)$ Maturities & sales of non-marketable investments - - 494$ Cash collateral related to (from) securities lending 1,403$ (350)$ (2,428)$ Investments in reverse repurchase agreements (775)$ 425$ 450$ Proceeds from divestiture of business 386$ -$ -$ Acquisitions, net of cash acquired & proceeds received from divestiture, & purchases of intangible & other assets (4,888)$ (236)$ (986)$

Net cash flows from investing activities (21,055)$ (23,711)$ (31,165)$ Financing activities:

Net proceeds (payments) related to stock-based award activities (2,069)$ (2,375)$ (3,304)$ Excess tax benefits from stock-based award activities 648$ 548$ -Adjustment payment to class C capital stockholders - (47)$ -$ Repurchases of capital stock - (1,780)$ (3,693)$ Proceeds from issuance of debt, net of costs 11,625$ 13,705$ 8,729$ Repayments of debt (11,643)$ (13,728)$ (10,064)$

Net cash flows from financing activities (1,439)$ (3,677)$ (8,332)$ Effect of exchange rate changes on cash & cash equivalents (433)$ (434)$ (170)$

Net increase (decrease) in cash & cash equivalents (551)$ (1,798)$ (3,631)$ Cash & cash equivalents at beginning of period 18,898$ 18,347$ 16,549$ Cash & cash equivalents at end of period 18,347$ 16,549$ 12,918$

Alphabet Inc.Cash Flow Statementin MillionsFiscal Years Ending Dec. 31 2017E 2018E 2019E 2020E 2021CVOperating activities:

Net income (loss) 24,020 27,359 30,698 35,002 35,613 Depreciation & amortization of property & equipment 6,479 7,373 8,145 8,819 9,416 Amortization & impairment of intangible assets 682 541 430 341 271

Changes in assets and liabilities, net effects of acquisitions:Accounts receivable, net (2,299) (3,049) (3,303) (2,891) (1,520) Income taxes, net 214 840 866 896 845 Inventories (6) - - (11) 1 Deferred Income Taxes 473 - - - - Prepaid revenue share, expenses & other assets (541) (949) (1,028) (900) (473) Prepaid revenue share, expenses & other assets, non-current (2,234) (752) (815) (713) (375) Accounts payable 668 503 544 477 251 Accrued Compensation & benefits 69 880 835 731 565 Accrued expenses & other liabilities 996 1,324 1,435 1,256 660 Accrued revenue share 369 614 665 582 306 Deferred revenue 143 230 250 218 115 Deffered revenue, non-current 20 41 45 39 21 Other long-term liabilities 563 599 649 568 299

Net cash flows from operating activities 29,615 35,555 39,416 44,415 45,993 Investing activities:

Purchases of property & equipment (11,203) (11,453) (11,709) (11,970) (12,237) Increase in marketable securities (15,358) (12,743) (15,614) (17,588) (19,640) Purchases of non-marketable investments (1,293) (645) (703) (767) (836) Investments in reverse repurchase agreements - - - - -

Net cash flows from investing activities (27,855) (24,842) (28,026) (30,325) (32,712) Financing activities:

Short Term Debt - - - - - Long Term Debt 36 570 699 787 879 Proceeds from issuance of common stock - - - - - Repurchases of capital stock (3,510) (3,510) (3,510) (3,510) (3,510)

Net cash flows from financing activities (3,473) (2,940) (2,811) (2,723) (2,631)

Net increase (decrease) in cash & cash equivalents (1,714) 7,774 8,578 11,367 10,650

Cash & cash equivalents at beginning of period 12,918 11,204 18,978 27,556 38,923 Cash & cash equivalents at end of period 11,204 18,978 27,556 38,923 49,573

Alphabet Inc.Common Size Income Statement% of SalesFiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021CVRevenues:

Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%Depreciation & amortization of property & equipment 5.34% 5.51% 5.83% 5.93% 5.69% 5.37% 5.16% 5.20%Amortization & impairment of intangible assets 2.21% 1.24% 0.97% 0.62% 0.42% 0.28% 0.20% 0.15%Cost of revenue 31.38% 30.81% 32.12% 33.00% 34.00% 35.00% 35.00% 35.00%

Gross Profit 61.07% 62.44% 61.08% 60.45% 59.89% 59.34% 59.64% 59.65%Expenses:

Research & development expenses 14.90% 16.38% 15.45% 15.50% 15.50% 16.00% 16.00% 16.50%Sales & marketing expenses 12.32% 12.06% 11.61% 11.50% 12.00% 12.50% 12.50% 13.00%General & administrative expenses 8.87% 8.18% 7.74% 7.00% 7.00% 6.50% 6.50% 6.50%

Total costs & expenses 36.08% 36.63% 34.80% 34.00% 34.50% 35.00% 35.00% 36.00%Income from operations 24.99% 25.82% 26.27% 26.45% 25.39% 24.34% 24.64% 23.65%

Other Income (Expenses)Realized gains on available-for-sale investments, net 0.23% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Foreign currency exchange gains (losses), net -0.61% -0.56% -0.53% -0.40% -0.34% -0.29% -0.26% -0.24%Gain (loss) on marketable securities, net 0.00% -0.28% -0.23% -0.19% -0.16% -0.14% -0.12% -0.12%Realized gain on equity interest 0.19% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Gain (loss) on non-marketable investments, net 0.24% -0.17% -0.07% 0.00% 0.00% 0.00% 0.00% 0.00%Gain (loss) on diverstiture of businesses 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Interest & other income, net 1.16% 0.39% 0.48% 0.50% 0.50% 0.50% 0.50% 0.50%

Income before income taxesProvision for income taxes 5.51% 4.40% 5.18% 4.98% 4.78% 4.59% 4.64% 4.46%Net income from continuing operations 20.64% 21.80% 21.58% 21.97% 21.11% 20.25% 20.49% 19.68%Net income (loss) from discontinued operations 0.78% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Net income 21.42% 21.80% 21.58% 21.97% 21.11% 20.25% 20.49% 19.68%

% of SalesFiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021CVAssets:Current Assets:

Cash and Cash Equivalents 27.80% 22.07% 14.31% 10.25% 14.64% 18.18% 22.79% 27.40%Marketable Securities 69.77% 75.37% 81.33% 81.20% 78.33% 77.27% 78.87% 85.32%Total cash, cash equivalents, & marketable securities 97.57% 97.44% 95.64% 91.45% 92.97% 95.45% 101.66% 112.72%Accounts receivable, net allowance 14.22% 15.41% 15.66% 15.03% 15.03% 15.03% 15.03% 15.03%Receivable under reverse repurchase agreements 1.33% 0.60% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Deferred income taxes, net 2.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Income taxes receivable, net 1.97% 2.54% 0.11% 0.42% 0.36% 0.32% 0.29% 0.28%Inventories 0.00% 0.00% 0.30% 0.25% 0.21% 0.18% 0.17% 0.16%Prepaid revenue share, expenses & other assets 5.17% 4.19% 5.07% 4.68% 4.68% 4.68% 4.68% 4.68%

Total current assets 122.25% 120.17% 116.77% 111.83% 113.26% 115.67% 121.83% 132.87%Prepaid revenue share, expenses & other assets, non-current 4.97% 4.24% 2.02% 3.71% 3.71% 3.71% 3.71% 3.71%Non-marketable investments 4.67% 6.91% 6.51% 6.56% 6.03% 5.62% 5.44% 5.60%Deferred income taxes 0.33% 0.42% 0.00% 0.00% 0.00% 0.00% 0.00%Property & equipment, net 36.19% 38.69% 37.92% 35.63% 33.21% 30.75% 29.13% 29.06%Intangible assets, net 6.98% 5.13% 3.66% 2.40% 1.61% 1.09% 0.77% 0.58%Goodwill 23.63% 21.16% 18.24% 15.06% 12.71% 10.86% 9.64% 9.10%

Total assets 198.68% 196.64% 185.55% 175.20% 170.52% 167.69% 170.51% 180.91%Liabilities and Stockholders' EquityCurrent Liabilities:

Accounts payable 2.60% 2.58% 2.26% 2.48% 2.48% 2.48% 2.48% 2.48%Short-term debt 3.04% 4.30% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Accrued compensation & benefits 4.65% 4.72% 4.40% 3.70% 3.80% 3.80% 3.80% 3.90%Accrued expenses & other current liabilities 6.72% 6.36% 6.81% 6.53% 6.53% 6.53% 6.53% 6.53%Accrued revenue share 2.96% 3.11% 3.26% 3.03% 3.03% 3.03% 3.03% 3.03%Securities lending payable 4.21% 3.24% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Deferred revenue 1.14% 1.05% 1.22% 1.14% 1.14% 1.14% 1.14% 1.14%Income taxes payable, net 0.15% 0.40% 0.61% 0.34% 0.32% 0.31% 0.32% 0.30%

Total current liabilities 25.46% 25.75% 18.56% 17.21% 17.30% 17.28% 17.29% 17.38%Long-term debt 4.89% 2.66% 4.36% 3.63% 3.50% 3.46% 3.53% 3.82%Deferred revenue, non-current 0.16% 0.20% 0.22% 0.20% 0.20% 0.20% 0.20% 0.20%Income taxes payable, net, non-current 5.16% 4.88% 5.18% 4.98% 4.81% 4.66% 4.63% 4.84%Deferred income taxes 2.99% 0.25% 0.25% 0.29% 0.24% 0.21% 0.18% 0.17%Other long-term liabilities 1.69% 2.43% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95%

Total liabilities 40.35% 36.18% 31.53% 29.26% 29.02% 28.77% 28.79% 29.36%Shareholders' equity:

Class A & class B common stock & class C capital stock additional paid-in capital 43.59% 43.98% 40.22% 30.00% 22.60% 17.01% 13.04% 10.37%Accumulated other comprehensive income (loss) 0.04% -2.50% -2.66% -2.20% -1.85% -1.58% -1.41% -1.33%Retained earnings 114.70% 118.98% 116.46% 118.13% 120.76% 123.51% 130.10% 142.51%

Total stockholders' equity 158.33% 160.46% 154.02% 145.93% 141.50% 138.93% 141.73% 151.55%Total liabilities and shareholders' equity 198.68% 196.64% 185.55% 175.20% 170.52% 167.69% 170.51% 180.91%

Alphabet Inc.Value Driver Estimationin MillionsFiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 202CV

NOPLATEBITA:

Revenue 66,001 74,989 90,272 109,329 129,607 151,577 170,806 180,920 Depreciation Expense 3,523 4,132 5,267 6,479 7,373 8,145 8,819 9,416 Amortization Expense 682 541 430 341 271

Cost of Revenues 25,691 28,164 35,138 36,079 44,067 53,052 59,782 63,322 Research and Development 9,832 12,282 13,948 16,946 20,089 24,252 27,329 29,852 Sales & Marketing Expenses 8,131 9,047 10,485 12,573 15,553 18,947 21,351 23,520

General & administrative Expenses 5,851 6,136 6,985 7,653 9,073 9,853 11,102 11,760 + interest on PV of Operating Lease 131.52 128.57 193.44 232.48 254.99 281.69 305.02 325.63

EBITA 16,628 19,488.57 23,909 29,150 33,167 37,180 42,386 43,106

Adjusted Taxes:Provision for income tax 3,639.00 3,303.00 4,672.00 5,444.41 6,201.21 6,958.10 7,933.54 8,072.06

+tax on PV of Operating Leases 28.93 28.29 42.56 51.15 56.10 61.97 67.10 71.64 - tax on interest income 144.97 55.29 82.46 103.86 123.13 144.00 162.27 171.87

Less Adjusted Taxes: 3,522.96 3,276.00 4,632.10 5,391.70 6,134.18 6,876.07 7,838.38 7,971.82

Change in Deffered Taxes:End DTL - End DTA 649.00 (62.00) (157.00) 315.80 315.80 315.80 315.80 315.80 Beg. DTL-Beg. DTA 421.00 649.00 189.00 226.00 315.80 315.80 315.80 315.80

Plus Change in Deffered Taxes 228.00 (711.00) (346.00) 89.80 - - - -

NOPLAT: 13,332.55 15,501.58 18,931.34 23,848.46 27,032.98 30,304.13 34,548.00 35,134.23

Invested CapitalNormal Cash (5% of sales) 3,300 3,749 4,514 5,466 6,480 7,579 8,540 9,046

Accounts Revievable 9,383 11,556 14,137 16,436 19,484 22,787 25,678 27,198 Inventory - - 268 274 274 274 285 284

Income tax receivable 1,298 1,903 95 460 471 481 492 503 Prepaid Exp 3,412 3,139 4,575 5,116 6,065 7,093 7,993 8,466

Operating CA 17,393 20,347 23,589 27,753 32,775 38,214 42,988 45,498

Accounts Payable 1,715 1,931 2,041 2,709 3,212 3,756 4,233 4,483 Accrued Exp 4,434 4,768 6,144 7,140 8,464 9,899 11,154 11,815

Accrued Compensation 3,069 3,539 3,976 4,045 4,925 5,760 6,491 7,056 Accrued Revenue Share 1,952 2,329 2,942 3,311 3,926 4,591 5,173 5,480

Deferred Revenue 752 788 1,099 1,242 1,472 1,722 1,940 2,055 Income Tax Payable 96 302 554 369 421 472 538 548

Non-interest CL 12,018 13,657 16,756 18,817 22,420 26,200 29,530 31,437

Other LT operating Assets:Net PPE 23,883 29,016 34,234 38,959 43,039 46,603 49,753 52,574

Prepaid Revenue 3,280 3,181 1,819 4,053 4,805 5,620 6,333 6,708 Intangible Assets 4,607 3,847 3,307 2,625 2,083 1,654 1,313 1,042

PV of Operating Lease 3,340 5,024 6,039 6,623 7,317 7,922 8,458 8,938 Total Other LT operating Assets 35,110 41,068 45,399 52,260 57,245 61,799 65,857 69,261

Other LT operating Liabilities:Deffered Revenue 104 151 202 222 263 308 347 367

Income Taxes Payable 3,407 3,663 4,677 5,440 6,240 7,065 7,906 8,752 Other long-term liabilities 1,118 1,822 2,665 3,228 3,826 4,475 5,043 5,341

Total Other LT operating Liabilities 4,629 5,636 7,544 8,890 10,329 11,847 13,295 14,460

Invested Capital 35,856 42,123 44,687 52,306 57,271 61,966 66,020 68,862

NOPLAT 13,333 15,502 18,931 23,848 27,033 30,304 34,548 35,134 Less: change in IC (IC1-IC0) 7,384 6,267 2,564 7,619 4,965 4,696 4,054 2,842

FCF 5,948$ 9,234$ 16,367$ 16,229$ 22,068$ 25,609$ 30,494$ 32,292$

NOPLAT 13,333 15,502 18,931 23,848 27,033 30,304 34,548 35,134 Beginning IC 28,471 35,856 42,123 44,687 52,306 57,271 61,966 66,020

ROIC 46.83% 43.23% 44.94% 53.37% 51.68% 52.91% 55.75% 53.22%

IC0 28,471 35,856 42,123 44,687 52,306 57,271 61,966 66,020 Multiplied by: (ROIC- WACC) 38.68% 35.08% 36.79% 45.22% 43.53% 44.76% 47.60% 45.07%

EP 11,012.40$ 12,579.66$ 15,499$ 20,207$ 22,770$ 25,637$ 29,498$ 29,754$

Alphabet Inc.Weighted Average Cost of Capital (WACC) Estimation

Risk Free Rate 2.918%Equity Risk Premium 4.65%Beta 1.141Cost of Equity 8.22%

Pre Tax Cost of Debt 3.85%Marginal Tax Rate 22.00%After Tax Cost of Debt 3.00%

Total Shares Outstanding 692.88Share Price $1,044.15Value of Equity $723,470

Long-Term Debt 3935PV of Operating Leases 6543Value of Debt $10,478

Total Value of Capital $733,948

Weight of Equity 98.57%Weight of Debt 1.43%

Weighted Cost of Equity 8.11%Weighted Cost of Debt 0.04%

Weighted Average Cost of Capital (WACC) 8.15%

Cost of Capital

Weight of Capital

Alphabet Inc.Discounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models

Key Inputs: CV Growth 4.30% CV ROIC 53.22% WACC 8.15% Cost of Equity 8.22%

Fiscal Years Ending Dec. 31 2017E 2018E 2019E 2020E 2021CV

DCF ModelNoplat 23,848 27,033 30,304 34,548 35,134 Less: Capital Expenditures 7,619 4,965 4,696 4,054 2,842 Free Cash Flows 16,229 22,068 25,609 30,494 32,292 Continuing Value (CV) 839,939 Discount Factor 1.08 1.17 1.26 1.37 1.37 Present Value of FCF 15,007 18,868 20,245 22,291 613,982 Total PV 690,393

Plus: Value of Non-Operating AssetsExcess Cash 8,404 Non-Marketable Investments 5,878 Marketable Securities 73,415 Value of Non-Operating Assets 87,697

Less: Value of Non-Operating LiabilitiesLong-Term Debt (3,935) PV of Operating Leases (6,543) Value of Non-Operating Liabilities (10,478)

Value of Equity 767,612 Shares Outstanding 693 Intrinsic Value 1,108 Partial Year Adjustment Value 1,166$

EP Model 2017E 2018E 2019E 2020E 2021CVEconomic Profit 20,207 22,770 25,637 29,498 29,754

Continuing Value 773,919 Discount Factor 1.08 1.17 1.26 1.37 1.37 Present Value 18,684 19,468 20,267 21,563 565,723 Total PV 645,706 Beginning IC 44,687 Value of Operating Assets 690,393

Plus: Value of Non-Operating AssetsExcess Cash 8,404 Non-Marketable Investments 5,878 Marketable Securities 73,415 Value of Non-Operating Assets 87,697

Value of Non-Operating LiabilitiesLong-Term Debt (3,935) PV of Operating Leases (6,543) Value of Non-Operating Liabilities (10,478)

Value of Equity 767,612 Shares Outstanding 693 Intrinsic Value 1,108 Partial Year Adjustment Value 1,166$

Alphabet Inc.Dividend Discount Model (DDM) or Fundamental P/E Valuation Model

Fiscal Years Ending Dec. 31 2017E 2018E 2019E 2020E 2021CV

EPS 34.84 39.86 44.91 51.41 52.49

Key Assumptions CV growth 4.30% CV ROE 12.99% Cost of Equity 8.22%

Future Cash Flows P/E Multiple (CV Year) 17.06 EPS (CV Year) 52.49 Future Stock Price 896 Dividends Per Share 0 0 0 0 0 Future Cash Flows 0 0 0 896

Discounted Cash Flows - - - 706

Value of Equity 706$ Partial Year Adjustment 736$

Alphabet Inc.Relative Valuation Models

EPS EPS Est. 5yrTicker Company Price 2017E 2018E P/E 17 P/E 18 EPS gr. PEG 17 PEG 18APPL Apple $167.46 $9.00 $11.16 18.61 15.01 12.4 1.50 1.21 BIDU Baidu, Inc. $238.93 $7.21 $9.38 33.14 25.47 3.8 8.63 6.63 FB Facebook, Inc. $180.33 $5.34 $6.52 33.77 27.66 28.0 1.21 0.99 MSFT Microsoft Corp. $84.22 $3.39 $3.77 24.84 22.34 10.6 2.35 2.11 ORCL Oracle Corp. $50.40 $2.94 $3.18 17.14 15.85 8.79 1.95 1.80

Average 25.50 21.26 1.75 1.53

GOOGL Alphabet Inc. $1,044.15 $ 34.84 $ 39.86 30.0 26.2 8.55 3.5 3.1

Implied Relative Value: P/E (EPS17) $ 888.33 P/E (EPS18) 847.57$ PEG (EPS17) 521.69$ PEG (EPS18) 520.82$

Alphabet Inc.Key Management Ratios

Fiscal Years Ending Dec. 31 2014 2015 2016 2017E 2018E 2019E 2020E 2021CV

Liquidity RatiosCurrent Ratio 4.80$ 4.67$ 6.29$ 6.50$ 6.55$ 6.69$ 7.05$ 7.65$ Quick Ratio 4.39$ 4.38$ 6.00$ 6.19$ 6.24$ 6.39$ 6.75$ 7.35$ Cash Ratio 1.09$ 0.86$ 0.77$ 0.60$ 0.85$ 1.05$ 1.32$ 1.58$

Activity or Asset-Management RatiosRecievables Turnover 1.94 1.97 2.07 2.13 2.17 2.12 2.01 1.80Fixed Asset Turnover 2.96 2.50 2.37 2.47 2.67 2.89 3.15Asset Turnover 0.55 0.54 0.57 0.61 0.63 0.64 0.63 0.58

Financial Leverage RatiosDebt Ratio 20.31% 18.40% 16.99% 16.70% 17.02% 17.15% 16.88% 16.23%Debt to Equity Ratio 25.49% 22.55% 20.47% 20.05% 20.51% 20.71% 20.31% 19.37%Long-term debt to capitilization 11.22% 6.05% 10.84% 12.11% 15.51% 20.33% 27.06% 36.81%

Profitability RatiosROA 11.68% 11.74% 12.37% 13.38% 13.26% 12.92% 12.83% 11.52%ROE 14.74% 14.54% 15.02% 16.09% 15.96% 15.58% 15.46% 13.80%Gross profit margin 61.07% 62.44% 61.08% 60.45% 59.89% 59.34% 59.64% 59.65%

Payout Policy RatiosDividend Payout 0% 0% 0% 0% 0% 0% 0% 0%Total Payout Ratio

Present Value of Operating Lease Obligations (2016) Present Value of Operating Lease Obligations (2015) Present Value of Operating Lease Obligations (2014) Present Value of Operating Lease Obligations (2013)

Operating Operating Operating OperatingFiscal Years Ending Dec. 31 Leases Fiscal Years Ending 1210.98359009162 Leases Fiscal Years Ending 1210.98359009162 Leases Fiscal Years Ending 1020.65510566467 Leases2017 828 2016 646 2015 598 2014 4992018 896 2017 781 2016 622 2015 4772019 905 2018 792 2017 634 2016 4382020 850 2019 766 2018 596 2017 4182021 765 2020 716 2019 576 2018 370Thereafter 3693 Thereafter 3705 Thereafter 3157 Thereafter 1836Total Minimum Payments 7937 Total Minimum Payments 7406 Total Minimum Payments 6183 Total Minimum Payments 4038Less: Interest 1394 Less: Interest 1367 Less: Interest 1159 Less: Interest 698PV of Minimum Payments 6542.6 PV of Minimum Payments 6039 PV of Minimum Payments 5024 PV of Minimum Payments 3340

Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases

Pre-Tax Cost of Debt 3.85% Pre-Tax Cost of Debt 3.85% Pre-Tax Cost of Debt 3.85% Pre-Tax Cost of Debt 3.85%Number Years Implied by Year 6 Payment 4.8 Number Years Implied by Year 6 Payment 5.2 Number Years Implied by Year 6 Payment 5.5 Number Years Implied by Year 6 Payment 5.0

Lease PV Lease Lease PV Lease Lease PV Lease Lease PV LeaseYear Commitment Payment Year Commitment Payment Year Commitment Payment Year Commitment Payment1 828 797.3 1 646 622.1 1 598 575.8 1 499 480.52 896 830.8 2 781 724.2 2 622 576.7 2 477 442.33 905 808.0 3 792 707.1 3 634 566.1 3 438 391.14 850 730.8 4 766 658.6 4 596 512.4 4 418 359.45 765 633.3 5 716 592.8 5 576 476.9 5 370 306.36 & beyond 765 2742.3 6 & beyond 716 2733.8 6 & beyond 576 2316.5 6 & beyond 370 1360.0PV of Minimum Payments 6542.6 PV of Minimum Payments 6038.5 PV of Minimum Payments 5024.4 PV of Minimum Payments 3339.6

Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding

Number of Options Outstanding (shares): 0Average Time to Maturity (years): 0.00Expected Annual Number of Options Exercised: 0

Current Average Strike Price: 0Cost of Equity: 8.22%Current Stock Price: $1,044.15

2017E 2018E 2019E 2020E 2021E 2022CVIncrease in Shares Outstanding: 0 0 0 0 0 0Average Strike Price: -$ -$ -$ -$ -$ -$ Increase in Common Stock Account: - - - - - -

Change in Treasury Stock 3,509,670,488 3,509,670,488 3,509,670,488 3,509,670,488 3,509,670,488 3,509,670,488Expected Price of Repurchased Shares: 1,044.15$ 1,130.02$ 1,222.95$ 1,323.52$ 1,432.36$ 1,550.15$ Number of Shares Repurchased: 3,361,270 3,105,856 2,869,849 2,651,777 2,450,275 2,264,084

Shares Outstanding (beginning of the year) 692,879,488 689,518,218 686,412,362 683,542,513 680,890,736 678,440,462Plus: Shares Issued Through ESOP 0 0 0 0 0 0Less: Shares Repurchased in Treasury 3,361,270 3,105,856 2,869,849 2,651,777 2,450,275 2,264,084 Shares Outstanding (end of the year) 689,518,218 686,412,362 683,542,513 680,890,736 678,440,462 676,176,377

VALUATION OF OPTIONS GRANTED IN ESOP

Ticker Symbol GOOGLCurrent Stock Price $1,044.15Risk Free Rate 2.92%Current Dividend Yield 0.00%Annualized St. Dev. of Stock Returns 16.20%

Average Average B-S ValueRange of Number Exercise Remaining Option of OptionsOutstanding Options of Shares Price Life (yrs) Price GrantedRange 1 0 0.00 0.00 -$ -$ Total 0 -$ 0.00 -$ -$

Technology Alphabet Inc. (NYSE: GOOGL) Recommendation: …...Alphabet incorporated on October 2,...

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Transcript of Technology Alphabet Inc. (NYSE: GOOGL) Recommendation: …...Alphabet incorporated on October 2,...