How Google's Alphabet became the largest company in the world

Google's parent company Alphabet is now officially the largest company by market capitalisation in the world with a value of £370 billion.

In fact the top four companies in terms of value are all American technology companies: Alphabet (£370bn), Apple (£360bn), Microsoft (£290bn), Facebook (£225bn).

Not one of these companies, except Apple, features in the top 50 companies in terms of revenue. The largest company in terms of revenue is Walmart with £335bn of sales. It comes in at 14th with a valuation of £150bn.

The reason for the dominance is the bull run of large dominant software companies where the average growth in share price has been over 40 per cent and Alphabet has seen a growth in share price of nearly 47 per cent in the last year.

This is quite spectacular by all accounts. Only Facebook has done better with a growth of 55 per cent. This compares to an essentially static NASDAQ.

Apple on the other hand is seeing its valuation decrease and has lost over 20 per cent of its value in the last year.

One of the reasons for the euphoria for software companies is the perceived infinite growth potential with limited extra spending open to them and the huge scale advantage to any software company.

Other companies, like Apple, have more defined markets which have better defined boundaries and limitations. This is why Alphabet trades on a P/E of 36 and Apple on a P/E of 10.

We believe this major valuation difference is the perceived market power each company has.

Apple, although one of the dominant brands in mobile phones and with a strong software component with iTunes, is not perceived as market dominant and therefore is perceived at running the risk of being displaced.

The analogy of its dominance in early PCs and its decline to minor, niche player creates some substance for this fear.

Furthermore analysts also believe that mobile growth will slow, and is seeing signs of slowdown and the ability of Apple to claim dominance of the next growth market is untested.

Google on the other hand dominates the market of online advertising without any question with 67 per cent market share and there is no other company that comes close to it.

The mobile advertising market was a potential problem but it is now already claiming 32 per cent of this market as well which shows its ability to migrate its dominance to new markets.

The market therefore believes that the sustainability and growth of the revenue stream of Google is much stronger than Apple.

Although Apple posted net income of over £14.2bn in Q4 2015 versus £4.7bn for Google, investors believe Google's profits will grow as it exerts its dominance further and Apple is going to decline as competitors will make its life more difficult.

Another major part of the Google valuation is the major investment in R&D it is making, about £7bn a year which is not yet delivering value but could.

There are other potential market dominant plays in Google that could become cash cows such as: Nest, Android, self-driving cars, Songza music streaming, electronic contact lenses, Project Loon to deliver cellular internet with balloons, renewable energy projects to name a few.

These projects are all potential ‘unicorns’ (£bn valued businesses) and have both good funding and with the new structure will be able to attract leading CEOs to bring them ‘home’.

The scale, scope and unchallenged success of Google therefore justifies the much higher valuation.

Will Google be able to grow its operating income to £40bn in the next five to 10 years to justify its valuation from the £16bn it posted in 2015? Only the future can tell. But on present performance I would certainly not bet against it.

Jacques de Cock is a faculty member at the London School of Marketing


Jacques De Cock

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