Google Stock: Adding On The Dip
Contributor since 2011 / 24763 Followers
Summary:
- Alphabet Inc.’s third quarter results were overshadowed by softer cloud revenue growth.
- Despite some soft spots in the earnings report, the company remains a solid long-term investment with strong growth potential.
- The current pullback provides an excellent opportunity to add to a long-term position.
pcess609
By the end of July, I believed that a re-rating of Alphabet Inc. (NASDAQ:GOOGL) aka Google stock seemed warranted as revenue growth accelerated, while the worst AI concerns (to potentially disrupt the core search engine of the business) were moving to the background.
Despite still somewhat concentrated activities (relative to other members of the magnificent seven), Alphabet still looked a compelling long-term play as this observation had not changed overnight (in at least the time frame of a quarter here). With expectations having come down a bit following a generally resilient third quarter earnings report, I remain confident in the long-term potential of the stock, in fact I am adding a bit to my position here.
Some Perspective
Alphabet was a $70 stock pre-pandemic as shares doubled towards the $150 mark by the fall of 2021. Even then, shares were lagging compared to other technology peers despite these returns. Shares fell to the $100 mark in the fall of 2022 amidst a reversal of momentum due to valuation and interest rate concerns, and shares even traded well below the $100 mark at the start of the year.
Other than macro concerns on growth and interest rates, it was really the hype around AI which caused an overhang on the share price, as a potential disrupter of the core search engine of the business.
All these factors impacted the business somewhat, as first quarter results (as released in April this year) revealed that revenues were up just 3% to $70 billion, although a strong dollar halved the reported growth numbers, as operating margins fell 5 points to 25%, due to slower sales growth and charges taken related to the optimization of the office footprint.
Second quarter sales rose some 7% to $74.6 billion, with a strong dollar only detracting 2 points from the reported sales growth, as operating margins improved a point to 29% of sales, with earnings reported at $1.44 per share.
A net cash position of $135 billion worked down to about $10 per share, with shares trading at $133 at the time. With earnings power trending close to $6 per share, the unleveraged business traded at around 20 times earnings, a reasonable valuation given the net cash position, solid growth, as well as strategic drivers.
These drivers include more focused AI business development practices, and rationalization of the business following headcount reductions. Moreover, the company saw another driver to the business, as interest income doubled to $892 million for the second quarter! Amidst all this, shares of Alphabet remained a cornerstone investment in my investment portfolio.
Struggling
Since July shares of Alphabet have gradually risen to the $140 mark in recent weeks, but shares have sold off to the levels seen in July (or even a bit lower), having fallen to $126 in the wake of the third quarter earnings release.
Third quarter sales rose by 11% to $76.7 billion, with a stronger dollar no longer creating a headwind to the reported revenue results. Google Advertising revenues were up 9% to $59.6 billion, as cloud revenue growth slowed down to 22%, with revenues reported at $8.4 billion.
It was this 22% cloud growth, which marked a six point growth slowdown from the second quarter of this year, which spooked investors. This was certainly the case as Microsoft (MSFT), which has a larger cloud business, actually saw quicker pace of growth, in fact even accelerating growth. Other Google revenues (at $8.3 billion) grew at a decent clip as well, with Other Bets growing sales 42% to $297 million.
Operating profits rose three points towards 28% of sales with reported operating income up 25% to $17.1 billion, in part due to the fact that the headcount was actually down more than 4,000 employees, standing at a current tally of 182,000 and change. The other driver, which started this year, was an extension of the estimated useful life of servers, lowering the deprecation expenses by nearly a billion this quarter.
These cost efforts meant that results improved across all segments, with Google Service revenues were up 27% to nearly $24 billion. Google Cloud posted a $266 million operating profit, comparing to a near half a billion dollar loss this period last year, as losses at Other Bets were relatively constant at $1.2 billion.
Net earnings grew 41% on the back of a lower tax rate and higher interest income, with earnings reported at $19.7 billion, as earnings per share rose to $1.55 per share amidst a 3% reduction in the share count on top of the dollar improvement in earnings. Net cash was preserved around $130 billion, equal to $10 per share.
Amidst all this, the situation is largely the same as in July, with both the share price, net cash holdings and earnings power being similar to July. In fact, Google shares are trading a little bit cheaper with shares now to $126 and change, while earnings power exceeds $6 per share here.
What Now?
Alphabet is the cheapest among the Magnificent Seven, and adjusted for cash and current multiple at around 20 times earnings the stock price looks quite reasonable, as the company just returned to double-digit sales growth.
Unlike some of its major technology peers, Alphabet is a bit more concentrated in terms of business activities, which has advantages but also drawbacks in terms of reliance and perhaps antitrust actions as well, as it does have some real dominant positions in some markets.
Given the large advertising component, Alphabet is somewhat susceptible to the economy slowing down, although it has sufficient secular growth plays within its portfolio in order to maintain growth, even if the economy slows down.
While there are some softer spots in the earnings report, mostly related to cloud, the overall report looks quite solid. I think that the current selloff feels a bit of an overreaction. Given this, I am maintaining a decent long position of Google shares here, in fact contemplating adding a bit on the dip here.
Analyst’s Disclosure: I/we have a beneficial long position in the shares of GOOGL either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha’s Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
If you like to see more ideas, please subscribe to the premium service “Value in Corporate Events” here and try the free trial. In this service we cover major earnings events, M&A, IPOs and other significant corporate events with actionable ideas. Furthermore, we provide coverage of situations and names on request!