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Paul Meeks

Paul Meeks

Alphabet’s December Quarter Impresses but Are the Stock’s Best Days Behind It?

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Alphabet (GOOGL, $2,752.88), like Prince, who became “the artist formally known as Prince,” became the company formally known as Google in 2015. Last year, Alphabet was particularly good to investors. Its stock was up a whopping 65%, which was more than any other FANG and over three times the return on the NASDAQ Composite Index. However, since the technology stocks correction began on Thanksgiving (November 22), the shares have fallen 6%, although Alphabet has fared better than many of its peers, particularly those profitless COVID creations whose stocks had reached lofty levels just as they had failed to grasp for post-pandemic growth.

Alphabet is the digital advertising king. In the quarter just ended, its total advertising business, which includes Google Search ($43.3 billion revenue), YouTube ($8.6 billion), and Google Network ($9.3 billion), posted $61.2 billion in revenue, which was +33% versus the same period last year. The Big Kahuna, Google Search, handily beat Street expectations, but YouTube slightly trailed forecasts although its revenues were still +25% year-to-year. Although they lose money, the Google Cloud ($5.5 billion revenue in the quarter) and Other Bets ($181 million) segments are Alphabet’s “juice,” according to many analysts (but not to us because we insist on profits and cash flow). Some bulls believe that Alphabet’s future growth drivers are within these businesses. 

One of the keys from this quarter’s report was that Google Cloud’s revenue grew 45% over the past year, which was about the same pace (+46%) for Microsoft’s competitive offering, Azure. Microsoft reported that growth when it announced its earnings on January 25. The top dog in this cloud infrastructure market, Amazon Web Services (AWS), will share its year-to-year growth when its parent reports its earnings on February 3. If you are keeping score, in the September 2021 quarter, these were the shares in this critical global market: AWS, 32%; Azure, 21%; and Google Cloud, 8%. Although Google Cloud only accounted for 7% of Alphabet’s revenue last quarter, and it lost $890 million within a wildly profitable company, its success is key to Alphabet’s valuation. Consider this: Although Amazon started AWS in 2006, its shares were catapulted furthest after it started sharing its AWS revenue with analysts in 2015. Since then, AWS has been the key to Amazon’s five-fold increase in market capitalization. If Google Cloud can take share from AWS and Azure and become profitable and then more so, Alphabet’s investors may turbo boost this stock, particularly if Alphabet continues to chug along in digital advertising. 

Overall, Alphabet’s quarterly performance was solid. Its advertising business wowed investors. Google Cloud kept pace with Azure in the cloud infrastructure, and both of these firms may have taken share from the leader, AWS. Furthermore, Google Cloud is narrowing its losses. In fact, this business lost “only” $890 million this quarter versus bleeding $1.2 billion a year ago. Although Alphabet added 16% to its payroll in 2021 to reach 156,500 heads company-wide, its revenues grew faster than total operating expenses because while sales and marketing and general and administrative costs outgrew revenues, cost of sales and research and development expenses were better controlled and more than offset other inflationary pressures. Therefore, the company’s operating margin expanded 1.6% to 29.1% year to year. This is significant because the rest of the world is complaining about how higher wages are crimping profits. Last, and this is important, Alphabet generated over $200 million in free cash flow, or surplus cash, each day last quarter. Impressive. No surprise, the stock rose as much as 9% in after-hours trading.

Alphabet announced a 20-for-1 stock split to be executed in July. The company had not split its shares since 2015. Investors, please note that while a stock split can get the juices flowing, it does not change shareholder value. What will happen this summer is that Alphabet’s shareholders will receive 19 shares for everyone that they own while the stock price will be divided by 20. Today, Alphabet’s shares closed at $2,752.88, so if the stock split were to occur today, a shareholder would own 19 more shares, or 20 total, each priced at $137.64 for no change in wealth.

We are often asked whether one should invest in Alphabet or Meta Platforms (FB). The latter reports its quarter on February 2. Although Meta may or may not pleasantly surprise us as much as Alphabet did today, we already have an answer. We prefer Alphabet for several reasons. First, although both firms have dominant digital advertising franchises, Alphabet likely has and will be less negatively impacted by Apple’s move to ask users of apps accessed through its iPhone operating system to opt into being tracked online. Second, Meta is under siege by regulators worldwide for its potential negative influence on users. And this may be the year that the U.S. Congress forces the company to split off Instagram and WhatsApp. Third, Alphabet has a great opportunity with Google Cloud in an important market that Meta does not serve. Fourth, we expect that Meta’s operating margin will contract as it dramatically increases its compliance costs. As mentioned above, Alphabet’s profitability has expanded. Last, although Meta’s valuation is less than Alphabet’s by most metrics, the disparity is not wide, and we feel that Alphabet’s premium is worth it for all the reasons discussed.

No surprise, we concur (and do not always) in advance with the Street sycophants that will praise the company in their post-quarter reports published tomorrow morning. We bet that Alphabet will again outperform most technology stocks in 2022.

Our semi-annual economic & markets update is almost here. Join us on April 13th to learn about the markets and hear from Paul Meeks, as well as other investment committee members regarding the markets.

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