At the end of October, Alphabet (NASDAQ:GOOGL) lost ground after the firm’s Q3 results disappointed investors. While the firm’s revenue came in above expectations, its EPS dropped to $10.12 from $13.06 in the year-ago quarter. That was a much steeper drop than analysts had been expecting, which sent Google stock more than 4% lower in just a few hours.
However, GOOG stock bounced back almost immediately, and then some, in the following days. Part of the reason for that was value investors, who swooped in to pick up the tech giant while its price was depressed.
A big part of GOOGL stock’s recovery can be attributed to analysts, though. Despite the firm’s EPS miss, they were mostly bullish on Google.
A FactSet survey showed that 19 of 46 analysts raised their price targets on Google stock, with the average target price rising to $1,455.88— representing an 11% upside from where the stock is trading today.
That’s because while the results looked disappointing on the surface, a deeper dive shows that Alphabet is seemingly in better shape than its EPS suggested. SunTrust Robinson Humphrey analyst Youssef Squali noted that Alphabet’s equity security investment losses resulted in a one-time loss of $1.5 billion. On top of that, a French tax settlement cost Google an additional $554 million in that quarter.
Time to Buy?
When you take those two major one-time losses out of the equation, Alphabet’s operating income actually beat last year’s figures. That rationalization prompted investors to return to Google and drive the share price higher.
But are investors overlooking a deeper weakness in Alphabet’s future growth story? Google exec David Drummond’s actions suggest as much. Drummond, Alphabet’s Senior Vice President of Corporate Development and Chief Legal Officer, sold $27 million worth of Google stock on Nov. 1.
Of course, insiders buy and sell their stock options all the time, and Drummond could be rebalancing his portfolio or he might need capital for an upcoming purchase, but that kind of major sale by someone in Google’s executive suite is enough to make investors question whether the firm’s future is on solid footing.
Bank of America analyst Justin Post pointed to a comment by Google CFO Ruth Porat during the Q3 earnings call as reason to be skeptical. Her comment that, “there would be variability in year-on-year revenue growth rates from quarter to quarter” signals trouble ahead. He said that rhetoric was similar to what was said during the firm’s Q4 call— Alphabet then went out to post a Q1 revenue miss.
Plus, the Q3 results confirmed a worrying upward trend in Google’s traffic acquisition costs. The firm has having to shell out more and more to drive traffic to its sites and collect advertising revenue.
Key Weaknesses
This isn’t the first time Google stock’s heavy reliance on advertising has been called into the spotlight. Google brings in the bulk of Alphabet’s overall revenue through ad sales. That’s a scary thought when you look at the challenges the firm is facing in that industry.
For one the firm has become a regulatory target for government agencies who says the way Google handles data and directs web traffic needs oversight. That increasing regulatory presence has opened the door for competitors to grab marketshare. Facebook (NYSE:FB) and Google have long been the top dogs in online advertising, but Amazon (NASDAQ:AMZN) has slowly been making its way toward the top as well.
Other Bets
Of course, Google stock is also well known for its many ‘other bets’ which include things like autonomous driving and biotechnology. While those endeavors are often used as proof that GOOGL stock is more than just an advertising company, they make up only a tiny fraction of the firm’s overall revenue. While autonomous driving is certainly gaining momentum, that part of Alphabet’s business is a long way off from moving the needle for Google stock.
The Bottom Line on Google Stock
For now, Google’s advertising business is generating enough cash to fund future growth projects. However, there’s some question as to how much longer that can continue.
The fact that David Drummond, who works closely with the firm’s legal issues, is selling now is certainly worrying from an investment standpoint. While it doesn’t make Google stock a sell, it should at least prompt investors to proceed with caution.
As of this writing, Laura Hoy was long FB and AMZN.
