Post-Earnings, Google Has Momentum. Why Some Investors Don't Agree
Investing.com | Apr 26, 2018 02:01
Judging by the market reaction after Google’s parent company, Alphabet (NASDAQ:GOOG), announced its first-quarter earnings this past Monday, April 23, 2018, it appears investors are uncertain about the stock.
Despite reporting its strongest earnings growth since the fourth quarter of 2009 and announcing it was increasing spending to catch up to its cloud and consumer-device business rivals, Google’s stock continues to remain under pressure. In fact, it sank more than 4% the day after it released its Q1 numbers.
After years of steady gains, surprisingly, since its most recent earnings release there are now two opposing forces—bears and bulls—pulling at Google's share price. Here's the rationale for each case:
h3 Bearish Case/h3Bears think that the pay-off from Google’s heavy spending on its cloud and device segments is uncertain. Even if the company succeeds at making a meaningful dent, it will still take years to see the impact on its bottom line. In the meantime, the company will face pressure on its margins, opening the door for its stock to underperform.
The world’s largest digital ad seller disclosed this week that its spent $7.7 billion on capital expenditures—triple what it spent during the same period a year ago. Analysts were expecting just $3.5 billion in capital expenditures for the first quarter for all of Alphabet's divisions.
This ramp-up in spending comes as Google strengthens its cloud computing business to compete with Amazon (NASDAQ:AMZN), in order to diversify its revenue base beyond digital advertising. But this isn’t a one-time battle for Google.
Chief Financial Officer Ruth Porat told investors during the conference call that this is going to be the trend for the company going forward. "I wouldn’t suggest a one-off in terms of the investment we’re making," she said. "We’re really building out to support the growth that we’re seeing."
According to Porat, the new funding will mainly go to strengthen the capabilities of the company's data centers, and toward laying new undersea cables, processors, networking equipment and Google’s artificial intelligence or machine learning business.
h3 Bullish Case/h3
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Bulls, on the other hand, take this spike in spending as a positive development. In their view, Google needs to spend money in order to make money and to lay the groundwork for sustainable growth. After neglecting these markets for years in favor of its main ad businesses, now is the time for Google to challenge Amazon and Apple (NASDAQ:AAPL) where it counts...on their home turf.
Until very recently, about 98% of Google's revenue came from its online ad business. Management has now woken up to the fact that it needs to diversify, when concerns about user privacy and new regulations targeting social media giants may hurt its ad business. In Europe, for example, the EU's General Data Protection Regulation kicks in next month. It codifies how personal data and the movement of that data should be handled, with the primary goal of giving control of that data to the individual European Union resident or citizen. In short, it changes how internet companies collect user data and the ways in which they can target ads.
I see Google’s increased spending as a positive development in the long-run, and I don’t think this should be a reason to turn bearish on this great company. Investors need to have some faith in management’s ability to drive results.
The good news is that that this increased spending arrives at a time when Alphabet’s revenue is growing at a more rapid pace. In the first quarter, Alphabet's net sales jumped 23.5%, the fastest since 2014.
The Bottom Line
Google’s traditional growth drivers via mobile search remain unchallenged while YouTube and programmatic advertising show robust growth. Investors should hold on to Alphabet stock.
Rather than seeing the additional outlay as a negative, investors should be reassured by the fact that management is taking advantage of this momentum and investing in areas, such as cloud computing, that have the potential to drive future growth. This is absolutely the right path for Google to take and will undoubtedly increase shareholder value.
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