ALPHABET, INC: A DIVIDEND STAR IS BORN?

Hell has officially frozen over. Alphabet Inc (AKA, Google) has finally declared a dividend. Perhaps no company has embodied the Silicon Valley, breakneck growth culture more than Google, so the maturation of the 90’s wonderchild comes as a shock to many. It shouldn’t. Although the culture of Silicon Valley has always demonstrated a strong preference for stock buybacks over dividends, recent precedent suggests that Google could become a dividend growth machine.

By The Sick Economist

Traditionally, Silicon Valley and dividends are like oil and water. First, tech companies are infamous for going years and years without profits. Instead they pump every available penny into expansion and R&D, in order to keep growing quickly at all costs. Second, even when these companies start to turn a profit, even a very substantial profit, they have always exhibited a strong tendency towards stock buybacks, instead of dividends. 

There are a few reasons for this. First, dividends can trigger taxes, while stock buybacks effectively return money to shareholders without triggering taxes. Given that many Silicon Valley firms are still controlled by just a few large shareholders (or even just one shareholder), a regular dividend can mean millions, or even billions in taxes for those influential shareholders. Stock buybacks, on the other hand, may cause the stock price to rise, but they don’t equate to taxable income. Many billionaires find this low tax arrangement to be preferable. 

Secondly, and perhaps most importantly, dividends are seen as stale and stodgy through the lens of Silicon Valley culture. By the “move fast and break things” ethos, any spare cash flow should be reinvested in new operations or R&D. Admitting that you have substantial spare cash flow is seen as tantamount to admitting that you can’t think of anymore worthwhile growth projects. To put it plainly, dividends were seen as a sign of slowing growth, the same way that a man realizes that he has hit middle age when he finds his own hair in his bathroom sink and he can’t read the fine print on labels anymore. Who wants to admit that they have hit middle age? 

Yet, there is a reason why there are millions of coffee cups and t-shirts that bear the slogan “Life begins at forty.”  Google’s recent entry into the world of dividends may represent the maturation of the original enfant terrible of the 90’s, but there are plenty of reasons to believe that the company’s middle age could be very good to shareholders. 

Microsoft, Macro Dividends 

Google isn’t the first software oriented company to hit middle age. In fact, Microsoft, which was founded a decade earlier than Google, has already blazed this trail. And the results have been dramatically positive for shareholders.  

Microsoft went public in 1986, but didn’t pay any dividend at all until 2003. So, despite legendary profitability, the company took 17 years to pay a dividend. Google isn’t that different. Google went public in 2004. So, it took Google about twenty years to pay a dividend. 

When Microsoft declared its first dividend in 2003, many in the analyst community saw this as a bad sign. As Reuters put it, 

A regular dividend is generally regarded as a mark of a mature company that cannot match earlier growth rates or stock gains, and tends to attract more conservative investors. It is the antithesis of what many tech companies aspire to in their early years.

Several of Microsoft’s peers have paid dividends for many years, but Intel Corp and International Business Machines Corp have increased payouts dramatically over the past 10 years. Hewlett-Packard Co has held its dividend unchanged since 1998. The holdouts are Apple Inc , which used to pay dividends but stopped in 1995, and Google Inc , which has never paid a dividend and says it doesn’t plan to. 

And indeed, Microsoft did struggle to grow for many years. Under Steve Ballmer, Miscrosoft went through a legendary “time in the wilderness.” It’s share price staid flat for a decade. In 2012, the share price was just about the same as it had been in 2002.

But don’t confuse a flat shareprice for stagnant revenue and earnings. In 2002, the company had gross revenue of $28 billion. By 2012, that number had grown to $73 billion. During the same time period, net profit grew from $5.36 billion dollars to a whopping $16.98 billion.   

That’s right, during Microsoft’s time in the wilderness, the company’s revenue tripled, and net income almost quadrupled, and yet the share price just didn’t move. 

Any seasoned investor knows that sometimes a company’s share price can become unmoored from economic reality. In these cases, a growing dividend can act as an insurance policy. From 2002, to 2012, Microsoft’s dividend grew in line with its actual revenues and profits, not the distorted perception of Wall Street Analysts and weekend speculators. In 2003, when the company initiated the dividend, the firm was paying $.23 per quarter. By the end of 2013, ten years later, that quarterly dividend had risen to $.97.   

To put it simply, the media had it all wrong. Microsoft’s dividend initiation was not a sign of slowing growth or stagnation. Rather, the dividend was an insurance policy on growth. As long as the company’s fundamentals kept growing, shareholders would be rewarded accordingly, regardless of the whims of “Mr. Market.”  The dividend turned out to be a focused, methodical way of channeling the benefits of growth to the shareholders, not the end of growth!  

Why shouldn’t it be the same moving forward for Google? The two companies have a lot in common. 

• Both deal primarily in cloud based software
• Both have a wide range of clientele (billions of individuals, many small businesses, and growing enterprise businesses.) 
• Both have transitioned from a founder managed structure to professional management overseen by hired executives, instead of founders 
• Most importantly, both have potential game changing growth projects that would transform the nature of the business. 

All and all, Microsoft has grown its dividend 1,000% since 2003. This has led to a compounded annual return over 16% and turned a $10,000 investment into $237,000. Not bad for a company whose growth has “stagnated.”  

Can Google do the same? What kind of growth prospects are on their plate? 

The 3 factors that Determine Dividend Growth 

The first thing that influences growth is the company’s overall financial position. How much cash does the company have on hand? How much debt does the company have? What percentage of their quarterly earnings are they already paying out as a dividend? 

If a “fortress balance sheet” is considered to be a good thing, Google currently boasts a balance sheet that looks like Fort Knox. In its latest quarterly report, the company had $407 billion in assets vrs just $114 billion in liabilities. The company had a monstrous $108 billion in cash on hand, vrs just $13 billion in debt. 

The company’s new dividend will begin at just $.20 per share, while the company earned $1.89 per share. In the world of dividend growth investing, anything under a 50% payout ratio is considered to be a strong financial position for future growth. Google is starting out with a payout ratio of just 10.5%. 

Between Google’s mind boggling cash position and powerful ongoing earnings, the company could grow its dividend for years, even if earnings growth were sub-par. 

And there is no reason why earnings should be sub-par. The second major factor in a company’s ability to grow their dividend is the strength of their underlying, core business. As Warren Buffet is famously quipped:

“The single-most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by a tenth of a cent, then you’ve got a terrible business. I’ve been in both, and I know the difference.”

Anyone who has attempted to own and/or operate a small business in the United States, or even most of the world, will tell you that Google has plenty of pricing power. Most small businesses cannot survive without Google. Their Google listing on Google search is of prime importance, and a successful (or not successful) Google ad campaign can make or break any small or medium sized firm. 

The proof of this is in the earnings. In 2014, Google earned $57.9 billion in revenue. For 2023, that number was $307 billion. In just ten years, Google almost quintupled its revenue. Most of this came from long established businesses, like search advertising and Youtube advertising. Even if the older, more mature Google only grew at half that rate moving forward, that would be more than enough cash flow to raise the dividend constantly. 

Lastly, we need to ask: what new lines of business could be on the horizon? You and I might be happy enough with a slower rate of growth, but that is not how Wall Street works. Wall Street analysts and major league capital allocators will constantly hound Google for growth so that we don’t have to. 

Keeping that in mind, the company has a number of juicy growth prospects. These are all new lines of business that could re-invigorate our aging company. 

Cloud and Enterprise Business

Google has become the number three provider of digital cloud based services to large businesses. These are the data centers and digital architecture that allows big companies to store nearly endless quantities of data. With the advent of AI, corporate America’s ravenous need for data storage and infrastructure is expected to grow at a dizzying pace. In just one year, Google’s nascent cloud business grew from $7.4 billion in revenue, to $9.5 billion. 

AI

Google itself is becoming a major player in the world of artificial intelligence. If you pay attention closely, your search results over the last few years have become much more accurate and detailed information is much easier to find. That is AI. Such pre-existing know how is now coming to market in the form of Google’s Gemini, a proprietary generative AI.  Although the product stumbled right out of the gate, it is very early in this race, and Google’s pre-existing expertise in AI, and unparalleled access to consumers, may give it a substantial advantage when the industry hits the growth stage.  

Waymo Self Driving

Waymo, fully owned by Google, has been nothing but a money incinerating machine for many years. However, the company is now pulling into pole position as the leader in this field. As rivals have suffered safety disasters and fallen by the wayside, Waymo just keeps expanding, slowly but surely.  It’s looking more and more possible that all of those multi-billion dollar losses were simply investments towards the next lucrative bonanza. Just think Uber, but without the pesky costs of a human driver. Sound lucrative? It just might be. 

If the market were perfectly efficient, if the perception of the market participants always matched reality, then it would be awfully hard to earn a buck in the stock market. But markets aren’t always perfectly efficient, and many analysts and big league capital allocators often miss the obvious opportunities sitting right in front of them. That’s how we make money. 

The technosphere’s widespread perception that a dividend is ‘“bad news,” because it means slower growth, can be just plain wrong. As we saw with the example of Microsoft, when that tech titan initiated a dividend, the firm’s most lucrative days had just begun. 

It may very well be the same with Alphabet (AKA: Google). We don’t need artificial super intelligence to see a strong possibility that Google’s dividend is primed for hyper growth.