By now, most investors are likely aware that Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) missed on both the top and bottom lines when it announced its first-quarter results Monday after the close of markets. Alphabet stock dropped by almost 8% on the news.
Naturally, investors were fretting over the possible slowdown of the company’s advertising cash cow. Other possible downers included lower smartphone sales, fewer YouTube clicks on ads and expenses that continue to grow at a faster pace than revenues.
It all adds up to eight analysts lowering their price target for Alphabet stock, a move that’s cut $70 billion in market value in a single day.
No wonder investors are freaking out about GOOGL stock. However, before you call your broker to dump Alphabet shares, you might want to take a deep breath and consider the following seven reasons to hang on to the advertising dynamo …
The future still looks very bright for Alphabet despite the doom and gloom hanging over GOOGL stock in the near term. Here’s why:
Revenue Growth Is Healthy
Analysts were expecting Alphabet to post revenues of $36.3 billion in the first quarter. It came in about $1 billion short. That’s the bad news.
The good news is that revenues excluding currency increased by 19% over last year’s $31.1 billion. That followed a strong first quarter of 2018 that saw revenues increase by 23%. If you stack the two years together, you’re talking about an average annual growth rate of 21% over the past 24 months.
Retailers would kill for this kind of growth.
Another positive: all of its various segments had growth in Q1 2019 including a 25.1% increase from Google’s “other revenues,” not to be confused with its “other bets.”
Regionally, Asia/Pacific saw a 31% increase in revenues to $6.1 billion, boosting the percentage of revenue it generates from the region to 17%, 200 basis points higher than in the same quarter a year earlier. Double-digits are surely just around the corner.
Analysts Still Like GOOGL Stock
Although eight analysts cut the price target on the news, Alphabet is still a very bullish stock in the eyes of the professionals. Forty-three analysts cover Alphabet. Only two of them have a “hold” rating on the stock with the rest giving Google’s parent a big thumb’s up.
“Leaving aside the short term debate (as a stock overhang), we still see GOOG as a key long term holding and nothing in this quarter changes our view on the structural drivers of revenue growth and FCF generation (AI/machine learning, local advertising, media consumption, cloud computing, hardware & Other Bets) – especially at what we see as a reasonable absolute valuation when measured against growth,” stated UBS, who has a buy rating on GOOGL.
The average target price of analysts is $1,356, providing 12-month upside of approximately 14%.
A Third of Online Ad Revenue
Although a lot’s being made of Google’s competition gaining on the industry leader — Amazon’s (NASDAQ:AMZN) advertising revenue increased approximately 34% in the first quarter to $2.7 billion — the reality is that Google still captures around 33% of the global online advertising revenue with Facebook (NASDAQ:FB) a distant second at 20%.
With three billion users, Google’s going to have a hard time slowing its ad growth despite both Amazon and Facebook growing revenues by 26%-34% a quarter.
Interestingly, in the first quarter, the company’s total cost of revenues as a percentage of revenues was 44.1%, 90 basis points higher than in the same quarter a year earlier. Although that seems like a lot, it’s only an increase equal to the company’s growth in Q1 2019 revenues.
It’s likely that it increased certain costs in the first quarter as a strategic move that will pay dividends in subsequent quarters. It’s anything but a big deal.
As someone who’s moved from a Mac desktop to a PC laptop, I can say unequivocally that Google Drive has made my life a lot simpler. No wonder so many people stick with just Apple (NASDAQ:AAPL) products. It’s a major pain to go between the two ecosystems.
Google Cloud might not be in Amazon or Microsoft’s (NASDAQ:MSFT) when it comes to the cloud, but the company continues to grow this segment of the business, which is reported under other revenues along with Google Play, its hardware offerings, and YouTube subscriptions.
In the first quarter, Google’s operating expenses grew by 20% year over year to $12.0 billion, much of it for expenses related to increased headcount in its cloud operations. Interestingly, while the company’s research and development costs increased by almost a billion dollars in the quarter, R&D costs as a percentage of revenues increased by only forty basis points to 16.6%.
“Google Cloud Platform remains one of the fastest growing businesses in Alphabet with strong customer momentum reflected in particular in demand for our computer and data analytics products. Strong growth in Play was driven particularly by performance in APAC,” CFO Ruth Porat stated in the Q1 2019 conference call.
It might not get the attention the ad business does, but when that business eventually slows, it’s going to be operating units like the cloud that keep top-line sales growing at double digits.
Google Home and Assistant
While the Pixel smartphone has been a rare Google disappointment, CEO Sundar Pichai was all smiles when it came to discussing Google Home and Google Assistant during the first quarter conference call.
“If you take AES like Google Home and Assistant products, we are doing well. We see strong momentum. I think we are market leaders in the category and especially when you take a look at it on a global basis,” Pichai stated April 29.
However, it’s not so much the hardware that’s exciting, but rather the artificial intelligence behind Google Assistant that’s so interesting.
You can now use Google Assistant to book a restaurant on your Android or iOS device by simply saying where you want to go and at what time and it does the rest. Another example: You can be walking down the street, take a picture of your surroundings, and Google Maps will tell you where you are. That will come in handy when traveling in unfamiliar cities in town
Nonetheless, like Google’s cloud, it doesn’t get a lot of the hype, but it’s the future of the company.
Its Other Bets
The bets Alphabet is making in this area continue to bleed red and will for some time. In the first quarter, its other bets had an operating loss of $868 million, 52% higher than a year earlier, on revenues of $170 million, 13% higher than in Q1 2018.
The expenses are rising much faster than the revenues.
Right now, its three highest-profile bets are Waymo (self-driving vehicles), Wing (delivery drones), and Loon (internet services via balloons). Of the three, Wing appears the closest to actual commercialization.
I recently stated that the drone-delivery business is not a reason to buy Alphabet stock. I wasn’t negative about the company. Instead, I was being realistic about the business model. While there is a precedent for consumers paying for delivery — think food delivery services — it’s going to take huge economies of scale to get the business to profitability.
In the meantime, however, it’s vital that Alphabet continue to make these kinds of bets. Innovation doesn’t stop to rest.
Massive Free Cash Flow
Alphabet finished the first quarter with $7.4 billion in free cash flow, 70% higher than a year earlier. That’s a little inflated due to two real estate acquisitions in 2018. The first was a $1 billion buy in San Francisco; the second, a $2.4 billion purchase in New York City. If you exclude those capital expenditures, the growth in free cash flow wouldn’t be quite as high.
Nonetheless, it’s a lot easier to operate a business when it’s bringing in $21 billion more than it’s sending out each year.
Free cash flow, in my opinion, is the linchpin of any stable business. For every dollar of sales at Alphabet, it generates approximately 15 cents in free cash flow.
There’s not much to say about its earnings power except that it’s exceptional regardless of what happened in the first quarter.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.