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Highlights:
- Strong Q2 Performance: Alphabet (NASDAQ:GOOGL) beat both EPS and revenue estimates in Q2 2024, with EPS at $1.89 (a 31% year-over-year increase) and revenue at $84.64 billion (a 15% year-over-year increase). Google Search revenues were particularly robust, growing by 14%.
- Short-Term Concerns: The stock paused its rally due to high CapEx spending, concerns over Google Cloud’s margins, and uncertainties about AI investments. Q3 operating margin guidance was more conservative, reflecting increased expenses and investment levels.
- Long-Term Growth Potential: Alphabet remains a strong investment due to its diverse portfolio, with Google Services (ads, subscriptions, platforms, devices) accounting for 87% of total revenue. Despite short-term concerns, the strong growth of Google Search, which represents 57% of revenue, supports a bullish outlook. The current valuation presents a potential buying opportunity with a forward P/E of 22.3x.
Alphabet's (NASDAQ:GOOGL) stock rally hit a pause after its impressive second-quarter earnings report, which beat both EPS and revenue estimates. This cool-down is attributed to high CapEx spending, concerns over Google Cloud’s margins, and questions about the impact of AI investments. However, considering Alphabet’s diverse portfolio and the underappreciated growth in its Search business, I remain bullish. The stock is now trading at more de-risked levels.
In this article, I'll explain why Google's Q2 performance was strong and why the market is focusing on short-term issues rather than genuine threats to the investment thesis.
Alphabet’s Q2 Earnings: Strong Performance with Minimal Criticism
Alphabet delivered a robust Q2 performance, surpassing consensus estimates for the sixth consecutive quarter. EPS came in at $1.89, beating the expected $1.85, and representing a 31% year-over-year increase. Operating margins improved to 32% from 29% in Q2 2023, demonstrating effective cost management.
Revenue also impressed, with Alphabet reporting $84.64 billion, a 15% year-over-year increase, exceeding expectations of $84.22 billion. Google Search revenues were particularly strong, growing by around 14%.
Despite competition from Microsoft’s (NASDAQ:MSFT) Bing, Google maintains a dominant 91% share of the global search market, slightly down from 92.2% at the end of 2022. YouTube ads grew 11% year-over-year to $8.66 billion, though they fell short of the $8.93 billion consensus estimate.
Short-Term Concerns vs. Long-Term Potential
As expectations for AI investments rise, Alphabet’s Q3 operating margin guidance fell short of market hopes. Alphabet’s CFO indicated that margins will be more conservative in Q3 due to increased depreciation, expenses, and high investment levels. Additionally, management hinted at maintaining or even increasing CapEx by year-end, raising concerns about potential overspending relative to short-term returns.
Why Alphabet’s Long-Term Growth Story Remains Strong
Amid concerns about AI’s impact on Google’s search business, it’s important to remember that Alphabet is primarily an ad-driven company. Google Services, including ads, subscriptions, platforms, and devices, accounts for 87% of total revenues, with Google Search representing 57% of the revenue last quarter. In contrast, Google Cloud contributed just 12% of total revenue.
Google Cloud is currently receiving significant attention, but investors should not overlook the steady growth of Google Search. Q2 marked the sixth consecutive quarter of growth for Google Search, with double-digit increases in the last four quarters.
Given the nearly $200 billion Google Search business grew at 13.8% from Q2 2023 to Q2 2024, this strong growth is likely to outweigh any shortfalls in YouTube revenue or temporary headwinds in Google Cloud’s operating margins until Cloud investments start to pay off.
Valuation and Potential Opportunity
The recent sell-off has made Alphabet's valuation more attractive. GOOGL’s forward P/E stands at 22.3x, down from 24.5x prior to earnings. Historically, the average P/E over the past five years has been above 25x, indicating a potential buying opportunity.
