Alphabet Stock Is Still a Winner Despite Underwhelming Earnings

For the most part, when big tech companies reported second quarter earnings this year, they smashed estimates and their stock prices responded favorably. Facebook (NASDAQ:FB), Amazon (NASDAQ:AMZN) and Apple (NASDAQ:AAPL) all followed that general trend. One noteworthy exception? Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL). GOOGL stock hasn’t been climbing — it’s been falling.

the google play store, youtube and gmail apps on a cellphone screen
Source: BigTunaOnline/Shutterstock.com

While Alphabet did top second quarter revenue and earnings expectations, the beats were underwhelming, and the numbers themselves weren’t very good. Notably, Facebook, Amazon and Apple all managed to report positive revenue and profit growth in the quarter. Alphabet did not.

Long-term GOOGL stock investors shouldn’t worry too much about Alphabet’s underwhelming earnings.

The reality is that, while Alphabet is the least exciting of the big tech companies, it’s still a big tech company. Growing nicely. With healthy margins. Big long-term opportunities. And robust multi-year profit growth potential.

So stick with Alphabet’s stock. Shares will be just fine in the long run.

Here’s a deeper look.

Underwhelming Alphabet Earnings

Alphabet’s earnings weren’t good, especially when stacked up next to the earnings reports from Facebook, Amazon and Apple.

All three of those companies managed to grow revenues and profits in the quarter. Alphabet’s revenues were flat on a constant currency basis. Operating margins fell seven points year-over-year. Operating profits dropped 30%.

Breaking it down, Alphabet’s core ad business was weak. Total ad revenues dropped 8%, paced by a 10% drop in Google Search and partially offset by a 6% rise at YouTube. All three of those numbers are unimpressive. Facebook reported 10% ad growth in the quarter. Snap (NYSE:SNAP) reported 17% growth. Pinterest (NYSE:PINS) reported 4% growth.

In other words, Alphabet’s ad business is showing its age, and rapidly ceding market share to younger, faster-growing players.

Google Cloud did fine in the quarter. Revenues rose 43% year-over-year, which is exactly where you would expect that number to be up (below Azure’s 50% growth, but above AWS’ 29% growth in the same quarter). It’s also a slowdown from Q1 which, again, is exactly what you would expect, and is exactly what Azure and AWS did.

The “Other” businesses actually did pretty well. Google Play was strong. YouTube’s subscription services gained traction. But, in sum, strength in these ancillary businesses wasn’t enough to offset core ad weakness.

Broadly, then, Alphabet’s quarter wasn’t good, mostly because the core ad business struggled significantly.

Still a Great Company

Some bulls want to blame Alphabet’s weak Q2 on the coronavirus pandemic.

That blame is misplaced.

This is not a single quarter phenomena. Alphabet has, for years, been the slowest grower in the big tech space, mostly because the ad business is running against the law of large numbers, the cloud business has lagged industry peers and none of the other businesses have yet to make a big splash. Plus, margins have been a headwind for Alphabet for years, too, as a shift to mobile advertising has led to an increase in traffic acquisition costs for the ad biz, leading to historically anemic profit growth.

So, from an investment perspective, Alphabet has been the weakest company in big tech.

But it’s still one of the biggest tech companies in the world.

And as one of the biggest tech companies in the world, Alphabet’s future is still very bright.

As the irreplaceable, ubiquitous search backbone of the internet, Google Search and its ad business will sustain healthy growth over the next several years. YouTube will remain in hyper-growth mode thanks to a shift towards digital video consumption. Google Cloud will continue to benefit from rising cloud infrastructure demand tailwinds. YouTube TV could turn into a big platform as streaming TV adoption accelerates. The smart home business could scale nicely with 5G catalysts.

Plus, there’s Waymo just waiting in the wings. That business is widely considered to be the head-and-shoulders leader in self-driving. At some point in the not-too-distant future, Waymo could add serious firepower to the GOOGL stock growth narrative.

Net net, Alphabet may be the weakest in big tech behemoth, but it’s still a very strong company.

GOOGL Stock Is Reasonably Valued

My long-term model on Alphabet implies that GOOGL stock is fairly valued today, with room for upside through a Waymo breakout.

Excluding Waymo, I think Alphabet’s revenues will grow at a low double-digit pace over the next few years to $325 billion by 2025, while operating margins will improve as traffic acquisition costs moderate and as the cloud business scales. Assuming so, I think Alphabet is on track to do $100 in earnings per share by 2025.

Based on a sector-average 20-times forward earnings multiple, that implies a 2024 price target for GOOGL stock of $2,000. Discounted back by 8.5% per year, that equates to a 2020 price target of approximately $1,450.

Thus, by my numbers, GOOGL stock is fairly valued today.

But those numbers don’t incorporate any breakout from Waymo. If Waymo does launch some semblance of a self-driving ride-sharing business over the next few years and scales that business nationally — something which is entirely plausible — then that could billions of dollars in revenue to my estimates.

In that world, Alphabet starts to look undervalued here.

Overall, then, I think Alphabet’s stock is somewhere between reasonably valued to slightly undervalued territory today.

Bottom Line on Alphabet

Alphabet may be the weakest company in big tech. But it’s still one of the most strongest companies in the world, with a very bright future.

So don’t stress the bad Q2 earnings report. Play the long game here, and stick with GOOGL stock for the next several years.

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 rated one of the world’s top stock pickers 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 was long FB, AMZN, SNAP and PINS.


Article printed from InvestorPlace Media, https://investorplace.com/2020/07/alphabet-googl-stock-still-winner-underwhelming-earnings/.

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