Sean Gallup/Getty Images News
Sean Gallup/Getty Images News
Alphabet (NASDAQ:GOOG)(NASDAQ:GOOGL), owner of Google, needs no introduction. The firm has one of the few brand names that have become a verb and owns YouTube and Android besides that, along with a variety of moon shot type projects (self-driving cars, etc.). In my opinion, it isn’t knowable whether the moon shots will work out, but their core business has become part of the electronic plumbing of modern day life and is one of the truly excellent businesses in the world.
The firm has an A+ profitability grade from Seeking Alpha, which should come as no surprise. The moat here is obvious – everyone uses Google to search, and the ads get more relevant (and thus more valuable) the more you use it. That creates a flywheel of increasing profitability. It is also a beneficiary of more and more economic activity going online, as the first way people look for a new service provider is very often a Google search. Their financial metrics bear out this moat, with a recent return on equity of 30%, which would be higher if they didn’t have excess cash on their balance sheet. Their margins at all levels are also excellent, and they are investing through the income statement in the operating losses of their various moonshot projects, which obscures the unbelievable quality of their core business. After the recent market turbulence, the price of this business is not especially onerous, with Seeking Alpha having the forward P/E at 20X. All of this is well known, and so for this piece, I’m primarily focusing on the history and differences between their various share classes from the perspective of both a new investor and someone who already owns one and is wondering whether to switch.
Google has three classes of shares: the A, B, and C classes. When the firm first went public, they issued Class A shares with one vote per share, while the founders retained the Class B shares with 10 votes per share. This was designed to allow the founders to remain in control of the company. However, over time the issuance of additional Class A shares as stock options and as consideration for acquisitions began to dilute the control of the founders.
So in 2014 Google announced a stock split, where the existing holders of the A and B shares would get a new share of C class stock for every existing share held. The Class C shares are non-voting. This allowed for both the issuance of additional stock and for the founders to sell their new C class shares, without either action affecting their control of the firm. Now, there was quite an uproar at the time about this being shareholder unfriendly, but nearly a decade later the market doesn’t seem to have objected to the treble class share structure. In fact, the A and C shares (B isn’t traded) have consistently traded at almost the exact same value, and when they have diverged it has often been the non-voting C class that has traded at a premium.
The A class shares have the symbol GOOGL and come with one vote, while the C class shares have the symbol GOOG and come with no voting rights at all. The shares have the same economic interest in Google’s business, so other than voting rights there is really no reason to prefer one or the other. Since the Class B shares still have more than 50% of the votes, the voting power of the Class A shares is more theoretical than practical, and it certainly isn’t worth paying much for it. Also, with only 5% more Class C outstanding than Class A, as of the most recent 10-K, there isn’t much of a liquidity difference to the shares either. So for those buying shares, I’d recommend choosing whichever is cheaper, lately that has been the voting shares.
In fact, while I mostly invest in and write about small stocks, I do have a Google position. I have switched it from GOOG to GOOGL during the recent volatility, capturing a small spread in the process while keeping my economic exposure the same. There is really no downside to doing so, as I actually added voting rights (of admittedly negligible value) by doing the switch.
I held my GOOG shares in a registered account, so there was no taxation issue for me to switch, even though my cost basis in my GOOG shares was lower than the current price. For other investors who hold GOOG shares in a non-taxable account, making the same switch might be beneficial. For those who hold GOOG shares in a non-registered account, the situation is murkier. If you have embedded gains in the GOOG shares it is almost certainly not worth paying taxes to make the switch, as the spread is low. If you have embedded losses in the GOOG shares you would be at risk of having your trade ruled a wash-sale. I’m not a tax advisor and so I won’t offer an opinion on whether GOOG and GOOGL are “substantially identical” but that is a risk to consider. All that said, for new positions, I would definitely purchase the cheaper of the two, and taxes wouldn’t be a factor for that.
Alphabet is a wide moat business with excellent profitability metrics trading at an undemanding valuation. The GOOGL shares offer voting privileges that the GOOG shares do not. While those votes aren’t worth much, they don’t have a negative value and GOOGL has recently been trading at a discount to GOOG. I would always buy whichever was the cheaper of the two at the time I was making the purchase.
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I look for companies with a margin of safety to their value, and I dislike downside risk. I subscribe to the first rule of investing: “Do not lose money.”
I believe small and microcap stocks, as well as special situations, are the best place to look for value in the markets, as most people overlook these companies, making them more likely to be mis-priced. To exploit these opportunities, I have a subscription service with multiple microcap calls every month.
Associated with Seeking Alpha contributor “Canadian Income Investor”
Disclosure: I/we have a beneficial long position in the shares of GOOGL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.