Alphabet Inc Stock Will Be Back to Its Winning Ways in No Time

Tech giant Alphabet Inc (NASDAQ:GOOGL, NASDAQ:GOOG) has come far in a relatively short amount of time.

From early December into yesterday’s earnings report (so roughly two months), GOOGL stock had zoomed more than 15% higher from under $1,000 to above $1,150. So it’s no surprise that an earnings miss sent the stock tumbling about 4% lower, especially considering the rest of the market is spooked by higher interest rates.

But the report itself was pretty good. Margins are under pressure thanks to a shift toward mobile search, but such margin pressures should start to subside in 2018.

Meanwhile, it was yet another 20%-plus revenue growth quarter for GOOGL, underscoring the fact this growth narrative isn’t slowing at all. Plus, there are multiple catalysts on the horizon (YouTube TV, Waymo, Google Cloud, and Google Home) which should sustain healthy growth into the foreseeable future.

All in all, it wasn’t a bad quarter. Google stock just got ahead of itself going into the report.

I say let the dust settle. Let this market get less freaked out by interest rates (if you look at the numbers, the spread between the earnings yield and 10-Year Treasury yield is still very wide). And then buy GOOGL stock. I think this name should trade above $1,200.

Alphabet’s Strong Quarter

GOOGL had a really good quarter.

The company’s growth rate is seemingly unaffected by its ever-expanding size. No matter how big the business gets, growth still comes in above 20%. The fourth quarter was no exception. Revenue growth was 24%, the same as it was a year ago.

This big growth isn’t going anywhere any time soon. The growth narrative at GOOGL can be broken down into three phases, and we are in between the first and second phases right now, implying that Google’s growth runway extends out multiple years.

The first phase is the company’s booming advertising business. This includes the staple search engine Google and the video-watching platform YouTube, which has 1.5 billion monthly viewers. This business is supported by digital advertising, and digital advertising growth is enough to keep GOOGL’s revenue growth north of 20% for at least the next several quarters.

The second phase includes Google Cloud, Google Home, and YouTube TV. Google Cloud is now a $1 billion per quarter business. Not only is it one of the biggest cloud businesses in the world, but it’s also the fastest growing. And it’s growing where it matters (among big-paying customers). The number of deals greater than $1 million more than tripled in 2017 versus 2016.

Google’s hardware products, most of which lie in the Internet-of-Things (IoT) space, will continue to ramp. The smartphone business might face challenges, but the smart home business is already the second biggest player in the market. Meanwhile, YouTube TV has tremendous growth prospects thanks to cord cutting and the rise in over-the-top entertainment consumption. Read more here.

The third phase, which has yet to yield any financial benefits, is Google’s autonomous driving unit, Waymo. Waymo could be really big in 3-5 years. The company is currently the leader in the autonomous driving field, and GOOGL could leverage that leadership to make Waymo the first autonomous driving ride-sharing service in the world.

Indeed, Waymo is set to launch an autonomous driving ride service in 2018 in Phoenix. Just look at the valuations of Uber and Lyft in order to see how much value this service could add to GOOGL in the long run.

The Case for $1,200

While the 20%-plus revenue growth streak may be broken in the future, I don’t think that will happen anytime soon. Given the ramp in revenue growth throughout 2017 and big catalysts on the horizon, I don’t see revenue growth dipping below 20% any time soon. Will it happen over the next five years? Yes. But over the next two? Probably not.

Consequently, I think this is a high-teens revenue growth story over the next five years. Current margin pressures from higher-traffic acquisition costs should subside starting in 2018, according to management. Moreover, the company’s Other Bets segments should begin to ramp in profitability over the next five years.

Consequently, in that time frame, margins should actually improve. I think healthy margin improvement plus buybacks will turn high-teens revenue growth into 20% to 25% earnings growth.

Call it 22.5%. The S&P 500 is trading at a price-to-earnings/growth (PEG) ratio of 1.3. If you apply that same PEG to GOOGL stock, you get a fair forward earnings multiple of 29.25. A 29.25 multiple on 2018 earnings estimates of $41.60 gets you to a price target of above $1,200.