Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) reported excellent earnings last week, but in pulling apart the numbers, I started to wonder if GOOGL stock isn’t being priced appropriately for risk anymore.
I’m going to back out the $2.4 billion E.U. fine against the company so we get a true apples-to-apples comparison.
Alphabet revenues grew 21% year-over-year, which is astonishing when you consider a company of this size is still growing revenues at that rate. In fact, revenues were up 23% when you back out currency effects.
What GOOGL Stock Investors Need to Keep an Eye On
However, despite $26 billion in revenue, margins narrowed. This isn’t the end of the world, since they contracted 200bps to 26%, but it is a bit of a surprise. When combined with the fact that Traffic Acquisition Cost increased by 100bps to 22%, though, we see what could be a distant early warning regarding GOOGL stock and its core business.
We know that advertising and search are increasingly moving to mobile. That is to be expected. Mobile advertising is less profitable, for the most part. So there is some concern that this is both the beginning of a trend, and that Alphabet won’t be able to adjust to it. That’s why the shares fell 3% the next day, I think.
I’m not saying this is cause for worry, but it’s something to keep an eye on.
I also have to say that, when Alphabet purchased YouTube, I thought it was a dumb move to spend $1.65 billion on a platform that seemed to cater to cat videos. I think it now has proven to be a smart acquisition, in that it generates a ton of revenue, and allegedly has 1.5 billion monthly users. Although GOOGL stock reports don’t break out YouTube, which to me is a clear sign that it is not terribly profitable, the platform has still become valuable in and of itself.
There’s a long way to go towards increasingly monetizing the platform. If it ever figures out how to produce original content at value prices, it will be great for Alphabet stock.
Mind you, I said it allegedly has 1.5 billion monthly users. Just as Facebook Inc (NASDAQ:FB) claims to have 2 billion. I am dubious about these numbers. When you dig into the fine print of their 10-K’s, you’ll see that they aren’t even certain how accurate those numbers are. As with Twitter Inc (NYSE:TWTR), the valuation of these three companies depends entirely on how many users are true, active users. If advertisers ever find out that those numbers are inflated, look out below.
Bottom Line on Alphabet
Meanwhile, on a price-to-revenue basis, it is worth nothing that the market hands FB a 16x multiple, but only a 6x multiple for GOOGL stock. Backing out net cash, Alphabet and Facebook both trade at 37x TTM net income. Analysts see 27% annualized growth for FB vs. 19% for GOOGL stock. Therefore, one might concede that FB is the better buy here.
This, however, does not consider Alphabet and its “Other Bets” segment. If one of those bets pays off, its growth rate could increase. In this regard, much depends on how these bets interface and augment existing revenue streams. Only tech-heads may read this far into Google’s publications on AI and quantum computing, but here are the standouts to me:
“In the digital era, introducing a new technology has an exponential impact: even a 1% gain in product quality can help a company to achieve overwhelming growth in terms of user numbers or revenue … If early quantum-computing devices can offer even a modest increase in computing speed or power, early adopters will reap the rewards. Rival companies would face high entry barriers to match the same quality of services and products, because few experts can write quantum algorithms, and businesses need time to tailor new algorithms.”
So these Other Bets aren’t just venture capital investments. They are meant to improve and make the advertising algorithms more efficient. That may also mean GOOGL stock has much further to go.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.
