To be honest, I’m not a huge fan of Alphabet Inc (NASDAQ:GOOGL) stock. Obviously, the market heartily disagrees. GOOGL stock has gained more than 40% just since April – including 12% in 2018 alone.
Indeed, very quietly it’s become Alphabet, not Apple Inc. (NASDAQ:AAPL), that has the inside track to being the first company valued at over a trillion dollars. With AAPL scuffling ahead of a potentially dangerous fiscal Q1 earnings report on Thursday afternoon, its valuation gap over Alphabet has shrunk to less than $50 billion.
Though I still question GOOGL stock long-term, notably its continued reliance on advertising, I expect that gap to narrow this week. Alphabet is set up well for its Q4 report, also on Thursday after the close. The online advertising space remains strong by all accounts.
The “Other Bets” group has real promise, and investors remain willing to look past current operating losses toward future potential.
Broad markets have been rattled, and there are a couple of risks that could trip Alphabet stock up post-earnings. Still, this looks like a classic case of “the trend is your friend.” I expect the rally in GOOG and GOOGL stock to continue, at least for now.
Why Q4 Earnings Should Help GOOGL Stock
For all the talk about self-driving unit Waymo, the company’s Pixel smartphones, and IoT offerings like Nest and Google Home, Alphabet still gets the overwhelming majority of its revenue and profits from advertising. And there’s little reason to see strength in online advertising changing in Q4.
If anything, outperformance would seem most likely. Retailers performed reasonably well in the holiday period.
Competition was intense, and numerous brick-and-mortar players are shifting their spend online. 99% of the growth in U.S. online ad spend has gone to Google and rival Facebook Inc (NASDAQ:FB), which should help fourth quarter results for both companies.
And with Facebook apparently decreasing its ad load, Google’s growth could, or even should, accelerate.
Elsewhere, Alphabet is at least making progress. The acquisition of smartphone development assets from HTC will lead to an increased focus on the Pixel.
Alphabet may have more color on its launch plans for 2018. Operating losses in Other Bets have narrowed – and were huge in Q4 2016 last year, providing a beneficial comparison.
And, of course, there’s tax reform. Alphabet already holds a whopping $146 per share in cash. As of the end of 2016, per the 10-K, $52 billion was held overseas. The new corporate tax laws likely will cause a one-time GAAP impact to Q4 earnings but also allow Alphabet access to even more cash.
It’s not quite the windfall Apple will see. But Alphabet will have options, including acquisitions, share repurchases, or even a dividend.
The Risk in Q4 Earnings for GOOGL Stock
More broadly, it simply seems likely that Q4 earnings will be more of the same for Alphabet. Strong growth in advertising. Revenue growth and smaller losses elsewhere; and more cash, much more cash.
So what can trip up GOOGL stock in the report? It’s likely the advertising business, and notably two metrics: TAC and CPC. Traffic acquisition costs, what Google pays to get its traffic, have risen over time. Cost per click rates, what Google charges, are falling.
Both have been long-running concerns. Fears of CPC erosion dogged Alphabet stock back toward the beginning of the decade, when the company still was just called Google. Technical jargon aside, the fear is that margins are being pressured. As industry growth inevitably moderates, that in turn will lead Google’s profit growth to sharply decelerate.
I doubt that’s coming any time soon. On that front, it’s worth considering commentary from a major online retailer, Overstock.com Inc (NASDAQ:OSTK). On that company’s Q3 conference call, CEO Patrick Byrne bemoaned the amount of capital his competitors were spending on advertising.
He specifically pointed to online furniture retailer Wayfair Inc (NYSE:W), who reportedly bid $2 for a search term for which Overstock previously had paid $0.07.
There are tons of money-losing online ventures out there (think Blue Apron Holdings Inc (NYSE:APRN) as well). They all are bidding up for Google keywords. And that’s the short-term bull case for GOOGL stock as it targets a $1 trillion market cap and the long-term bear case.
At some point, those money-losing advertisers are going to pull back, or go bust. But clearly that time is a long way off – and until then, it seems unwise to bet against Alphabet stock.
As of this writing, Vince Martin has no positions in any securities mentioned.
