The ABCs of Alphabet

02/21/2018 5:00 am EST


Rob DeFrancesco

Founder, Tech-Stock Prospector

There was ample optimism in January headed into the Alphabet (GOOGL) Q4 earnings report; just two days prior to the release of Q4 results on February 1, the shares hit a new all-time high of $1,198, observes Rob DeFrancesco, editor of Tech-Stock Prospector.

But an earnings miss in the December quarter quickly switched short-term sentiment to bearish from bullish. Long-term investors now have the opportunity to once again accumulate Alphabet shares on weakness.

Yes, the Q4 earnings shortfall of 28 cents a share ($9.70 against the consensus estimate of $9.98) was both surprising and measurable. However, it was just one negative metric in an otherwise fairly upbeat earnings report.

Plus, there was a reasonable explanation for the EPS miss, and the headwinds causing the rise in expenses are expected to ease after Q1. Nonetheless, traders fixated on the shortfall, using it as an excuse to drive a major sell-off in the stock. Counterbalancing the negative, there were a number of Q4 positives, including total revenue advancing 24% to $32.3 billion, beating the consensus estimate of $31.8 billion.

Ad revenue of $27.2 billion rose 21.5%, representing slight acceleration from 21% growth in Q3. Google Site revenue was up 24%, driven by continued solid performances from mobile search and YouTube. Alphabet in Q4 showed steady top-line growth across all geographies.

Following the Q4 report, many Wall Street analysts came out in defense of the stock, with some even raising their price targets. Piper Jaffray took its target up to $1,350 from $1,300, saying it came away thinking Q4 was a net positive.

Barclays thinks 2018 could be a little choppy for Google, but raised its price target to $1,330 from $1,260, pointing out that the company has several growth levers. Morgan Stanley is a little more cautious (it reduced its price target by $15 to $1,200). But Citi remains upbeat, raising its target to $1,350 from $1,200, saying short-term margin pressure overshadowed solid Q4 revenue growth.

One thing Alphabet has going for it right now is its favorable valuation relative to growth. Since the Q4 earnings report, the 2018 consensus EPS estimate has come down 21 cents to $41.47, while the 2019 consensus has dipped 31 cents to $48.58.

The P/E on the 2018 consensus stands at 25.2, down from the peak multiple of 28.7 at the all-time high. The P/E on the 2019 consensus is down to 21.5 from the peak of 24.5. With Alphabet shares now trading at just 1.25x estimated 2019 EPS growth of 17.1%, there’s room for valuation upside.

There for sure should be some concern about the Q4 bottom-line miss, but Alphabet investors should know by now that the company has a history of paying more attention to revenue expansion on a quarterly basis.

It’s interesting to note that Alphabet a year ago reported Q4 2016 EPS that fell short of the consensus by 28 cents, while beating on the top line. In the following quarter, the company surpassed the consensus EPS estimate by 33 cents.

There are plenty of things to be optimistic about (including Google Cloud at $1 billion in quarterly revenue and YouTube at 1.5 billion monthly users), so we remain bullish on the stock.

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