Analyst Mark Shmulik from Bernstein identifies three key factors that contribute to the bull case for Alphabet Inc.'s stock. However, the company's recent earnings report has cast some doubt on two of these factors, at least for the time being.
AI Growth and Cloud Computing
Many had high hopes for the growth of Google's cloud-computing business, driven by advancements in artificial intelligence (AI). Unfortunately, Google fell short of expectations, with only a 22% growth rate in this sector during the third quarter. It was anticipated that growth would be closer to 28%, thus disappointing investors.
The management's commentary on "optimization efforts" suggests that customers are becoming more conscious about their spending. This has created concerns on Wall Street, causing Alphabet's stock to drop by 8% in morning trading on Wednesday. Nevertheless, the company's digital-advertising business continues to show healthy trends.
Shmulik compares the situation to Amazon.com Inc.'s AWS cloud-computing business, which has been struggling due to ongoing optimization issues. Although it is uncertain how widespread Google Cloud Platform's (GCP) optimization efforts are and how far customers have progressed, it is likely that these challenges will persist for several more quarters.
Operating-Margin Expansion
Shmulik expresses less enthusiasm about the potential for meaningful operating-margin expansion in the coming year. He highlights that Google's increased spending on AI, along with additional costs such as the annual $2 billion Sunday Ticket expense, necessitate a structural re-engineering of their cost base just to maintain operating margins in the high 20s. Consequently, this limited room for earnings and free-cash-flow expansion poses a challenge.
The Remaining Bull Case: Advertising Business
Despite the aforementioned concerns, there is still a prominent aspect of the bull case. Google's advertising business is significantly larger than its cloud business and has surpassed expectations in the latest quarter. Even Shmulik, who holds a market perform rating on Alphabet's stock and has reservations about the future of search in the AI era, acknowledges that the ad business seems well positioned to benefit from an extended and promotion-driven holiday season.
In conclusion, the recent earnings report has brought into question two aspects of the bull case for Alphabet Inc.'s stock. However, Google's advertising business presents a strong opportunity for growth, and it remains to be seen how the company will navigate the challenges in the cloud-computing sector and operating-margin expansion.
Search Results Above Expectations, Cloud Growth Soft: Analysis Report
Analysts' Perspectives
MoffettNathanson: Cost of Competition in the Battle for AI Supremacy
Michael Nathanson, an analyst at MoffettNathanson, expresses worry about the spending picture of Alphabet investors. According to him, the cost of competing in the race for AI supremacy is a valid concern. Although capital expenditures and employee costs have been restrained this year, he believes that the uncertain outlook will continue to impact the stock until further clarification is provided. Despite this, Nathanson maintains a buy rating on the stock with a revised price target of $155.
RBC Capital Markets: Challenges Ahead But Search Remains Resilient
Brad Erickson from RBC Capital Markets shares similar sentiments. Despite the challenges faced by the company, he highlights the resilience of the search division in uncertain macro conditions. However, he acknowledges that a cloud miss, increased capital expenditure due to generative AI implementation, and a lack of margin flow-through could limit the stock's upside potential compared to other major players. Erickson expects ongoing execution on search combined with GenAI implementation and YouTube acceleration to be a compelling proposition in the coming years. He maintains an Outperform rating on the stock with a target price of $155.
Wedbush: A More Positive Outlook for Alphabet
Scott Devitt from Wedbush offers a more positive perspective on Alphabet's performance. He compares owning Alphabet for its cloud business to rooting for Michael Jordan when he transitioned to baseball. Devitt believes that the stock market's reaction after-hours is an overreaction, and investors are placing too much emphasis on the company's Cloud segment, which constitutes only approximately 11% of its revenue. Devitt praises the acceleration in core advertising growth and maintains an outperform rating on the stock with a target price of $160.
Overall, despite mixed opinions from analysts, the search division remains resilient while concerns about the company's cloud business and future spending continue to loom over investor sentiment. However, with promising growth potential in various areas, Alphabet still holds promise in the eyes of many analysts.
Don't miss: Microsoft surpasses earnings estimates with remarkable cloud growth.
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