In April, Google parent, Alphabet’s (NASDAQ: GOOGL) stock price was punished when results disappointed investors. Last week, when the company’s results beat analyst expectations, the stock price soared 12%. These are big moves for a company worth $850 billion – but investors should prepare for more of this type of volatility in the future.
Last week’s results were indeed impressive and showed just how much of a cash-generating machine Alphabet is. Quarterly revenue came in at $38.9 billion, up 19% and $730 million ahead of estimates. Non-GAAP EPS were $14.21 and $2.75 better than expected. This result was as positive as the previous result was negative.
No More Low Hanging Fruit
The problem for Google is that consistently growing earnings off such a high base is going to prove challenging. In the second quarter, Google’s ad revenue grew by 16%, while the “Google other” segment grew by 40%. This includes revenue from the cloud and hardware businesses as well as the App Store. While these segments will continue to contribute to growth, it’s unlikely that this growth will be consistent or predictable.
This is the year that digital advertising will overtake traditional advertising in terms of spending. As far as disrupting the media industry goes, the low hanging fruit has already been picked.
Google is also facing increased competition from Amazon’s ad business, with the competitor winning the lion’s share of new ad spend from many advertisers. The company may also find itself facing new competition from China’s internet giants like Tencent and Baidu that have set their sights on international expansion.
While earnings can be massaged, top-line growth is very likely to gradually slow, or become erratic. Slowing or inconsistent growth would mean investors would be reluctant to chase the stock if or when it makes all-time highs.
Still Offering Value
None of this means Google is in trouble, and there is a lot to be optimistic about. The company owns at least 10 significant businesses including YouTube, Gmail, the cloud business and others. Then there are smaller projects that could become additional home runs for the company.
Analysts have pointed out that value will be unlocked if Google is broken up, or decides to spinoff assets like YouTube. If the company even considers separating parts of the business, it is likely costs will be managed more carefully. That will boost earnings more, as will the ongoing share buybacks. Even if top-line growth slows with time, earnings should show strong growth for a while to come. However, lumpy revenue growth will still make investors nervous.
Trade the Range
April’s earnings miss showed what can happen when Google disappoints investors. It’s very likely this will happen again in the future. However, Google is not that expensive, and the price will likely be supported at the lower levels. The chart is already suggesting a 20% range for the stock between $1,030 and $1,300 which would support that thesis.
While it’s probable this range will drift higher over time, large swings will probably continue within the range. Google can, therefore, be treated as a trading stock, as well as a long-term investment. There is also no need to chase the price when new highs are made.