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Strong Earnings Pave the Path for GOOG Stock to Top $1,400

Shares of Alphabet (NASDAQ:GOOG) popped after the digital advertising and cloud giant reported first-quarter 2020 numbers that were largely better than expected and included constructive commentary about the company’s growth trends during the novel coronavirus pandemic. In response to the strong print, GOOG stock rose about 10% to their highest levels since early March 2020.

Strong Earnings Pave the Path for GOOG Stock to $1,400

Source: rvlsoft / Shutterstock.com

Zooming out, Alphabet’s strong earnings pave a clear path for GOOG stock to run to $1,400 in 2020.

The rationale behind the bull thesis can be broken down into five key components:

  • Alphabet’s ad business is weathering the Covid-19 storm with impressive resilience, and will rebound quicker than expected.
  • The Google Cloud business remains on fire, and will sustain strong momentum over the next few quarters.
  • Various other Alphabet products — like Google Play, Google Classroom, and Google Meet — are seeing a surge in demand amid Covid-19.
  • Costs are swelling and adding pressure to margins, but the valuation on GOOG stock already fully accounts for this headwind, while not fully accounting for the aforementioned tailwinds.

All in all, while GOOG stock has come very far, very fast, this rally isn’t over just yet.

Strong Ad Business and GOOG Stock

The first-quarter earnings report confirmed that Alphabet’s ad business is both weathering the coronavirus storm with impressive resiliency, and positioned for a quick rebound.

Overall, Alphabet’s ad revenue growth rates slipped from 15%-plus in prior quarters, to about 10% in the first quarter. Google Search revenues were down by ~15% at the end of March, while YouTube revenues slipped into high-single-digit growth territory, from 30%-plus growth prior. Ad revenue trends at both YouTube and Google have largely stabilized in April around late-March levels.

Yes, that’s a big slowdown. But for the overall ad business to be, in aggregate, mostly stable amid a global economic shutdown is quite impressive.

Further, economic re-opening is already underway. Public perception surrounding the virus is changing as the science has changed to show that Covid-19 may not be that much more lethal than the flu. A potential treatment, remdesivir, is passing almost every test it comes across.

In other words, government policy, consumer behavior, and the general economic landscape will normalize much more quickly than expected. That paves the path for a speedy recovery in digital ad spending, and an equally speedy recovery in Alphabet’s ad business back to 15%-plus revenue growth.

Stronger Cloud Business

The first-quarter earnings report also confirmed that the Google Cloud business is indeed seeing robust enterprise demand amid worldwide physical office closures.

Google Cloud revenues rose 52% year-over-year in the first quarter of 2020, largely consistent with the 53% revenue growth rate the business recorded in the fourth quarter. Sustained big growth despite the broader economic shutdown was driven by strong demand for the company’s infrastructure offerings in the data and analytics platforms.

Strong cloud infrastructure demand tailwinds will persist for the rest of the year, and likely for the next several years, as companies continue to virtualize their offices.

As that happens, Google Cloud will sustain robust 50%-plus growth for the balance of the year.

Strongest Ancillary Businesses

Although advertising and cloud produce the overwhelming majority of Alphabet’s revenues and profits, it is important to note that many of the company’s other products and services are actually surging amid the pandemic.

Of note, Google Play downloads rose 30% month-over-month in March. Google Classroom doubled its user base since the beginning of March to over 100 million users. Google Meet engagement has risen by 30-fold since January, with the number of daily meeting participants now exceeding 100 million. Chromebook demand has surged amid the work-from-home and learn-from-home environment.

Yes, none of these businesses are individually big drivers of Alphabet’s revenues. But, in sum, they do move the needle. Alphabet’s “Other” revenues rose more than 20% year-over-year in the first quarter and were responsible for more than 15% of the total company’s revenue growth in the quarter (on a dollar basis).

Robust demand for these services will cool off in future quarters, but remain largely positive. In sum, these businesses will continue to contribute meaningfully to the company’s overall growth trajectory for the remainder of 2020.

Attractive Valuation for Google Stock

The one negative from the earnings report was that margins compressed.

Specifically, while traffic acquisition costs are now under control, rising data center and content acquisition costs are putting pressure on operating margins, which dropped four percentage points year-over-year. Due to this compression and sluggish revenue growth, Alphabet’s operating profits actually decreased year-over-year.

But, this cost-swelling is mostly priced into GOOG stock today. Upside from a quick ad business recovery is not.

Under the assumption that both revenue tailwinds and margin headwinds persist for the next several years, I reasonably see Alphabet marching towards $100 to $105 in earnings per share by 2025.

At the midpoint, that EPS target plus a 20-times forward earnings multiple (which is about average for technology stocks) and a 10% annual discount rate, imply a 2020 price target for GOOG stock of over $1,400.

Bottom Line on GOOG Stock

Google stock is a long-term winner that is weathering a near-term rough patch with impressive resilience. While the best of the recovery rally in GOOG stock has already materialized, there’s still more runway ahead. As the company’s fundamentals continue to improve in the back-half of 2020, Alphabet stock will keep rallying, and likely eclipse the $1,400 mark.

Luke Lango is a Markets Analyst for InvestorPlace. He has been professionally analyzing stocks for several years, previously working at various hedge funds and currently running his own investment fund in San Diego. A Caltech graduate, Luke has consistently been recognized as one of the best stock pickers in the world by various other analysts and platforms, and has developed a reputation for leveraging his technology background to identify growth stocks that deliver outstanding returns. Luke is also the founder of Fantastic, a social discovery company backed by an LA-based internet venture firm.  As of this writing, he did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2020/05/strong-earnings-goog-stock-top-1400/.

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