Going Into Earnings, Is Alphabet a Buy, Sell, or Fairly Valued?

What to look out for as Google parent company Alphabet reports earnings on October 24

Ali Mogharabi 18 October, 2023 | 2:53PM
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For Alphabet’s Q3 earnings report, we would focus mostly on advertising revenue growth in Search and YouTube.

1) For Search, we’d like to see whether the continuing macro uncertainty is impacting advertisers. We have assumed growth will continue in the second half of this year.

2) We still do not expect a material impact from Microsoft’s (MSFT) ChatGPT-powered Bing on Google Search this year. We’d like to hear whether Search is feeling any pressure from Bing or other search offerings powered by artificial intelligence.

3) We’d like the firm to provide more color regarding Bard and the Search Generative Experience, and where the usage of each compares with regular Google Search.

4) Regarding YouTube, we expect continuing top-line growth, to be driven mainly by direct response ads. We’ll also look for more color about contributions from broad-based campaigns, which could be an indicator of advertisers’ sentiment about the economy for the rest of the year.

In terms of the cloud segment, we will be focusing on profitability, as well as how much generative AI may have contributed to the top line.

We also expect colour regarding how much additional capital expenditure is needed going forward to accommodate the increased training and inference AI requires.

Regarding the overall bottom line, we’d like to have a better sense of the firm’s traffic acquisition costs, whether they will be increasing significantly as the firm likely renegotiates with Apple AAPL and/or Samsung, and to what extent the current search antitrust case against Alphabet is impacting the negotiations. Most of Apple’s testimonies in the trial have helped Alphabet, in our view.

Overall, our long-term view hasn’t changed, and we continue to view the stock as attractive.

Ratings Explained

With its 4-star rating, we believe Alphabet’s stock is undervalued compared with our long-term fair value estimate.

Our fair value estimate is $161.00 per share, equivalent to a 2024 enterprise value/EBITDA ratio of 17. We expect margin pressure in 2023, given the firm’s aggressive hiring in 2022, continued investments in growth initiatives, and the slight short-term impact of Bing and generative AI. We look for margin improvement in 2024-27, driven by better generative AI search monetization and faster growth in the cloud, driven by wider adoption of generative AI. Our model assumes a five-year compound annual growth rate of nearly 11% for total revenue and a five-year average operating margin of 24%.

We expect advertising revenue to remain over 70% of Alphabet’s total revenue, driven by continuing growth in overall digital ad spending, albeit at a much slower rate than it’s historically had. We model nearly 6% ad revenue growth for 2023 due to economic uncertainty. We have estimated total Google ad revenue of $233 billion in 2023 and $247 billion in 2024. We think YouTube will contribute about 13% of Google’s advertising revenue in 2023, similar to 2022, and 14% in 2024. YouTube growth should benefit from its impressive reach and usage frequency, plus its video-only content format, which is attractive to advertisers.

We believe the company will continue to gain traction in the cloud market, with 23% annual revenue growth through 2027.


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Ali Mogharabi  is an equity analyst for Morningstar

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