It’s safe to say investors were not very impressed with Alphabet’s (NASDAQ:GOOGL) latest quarterly update. Shares were taking a bit of a beating at the commencement of Wednesday’s trading, a development that might seem surprising at first, considering the search giant beat expectations on both the top-and bottom-line in Q3.
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Revenue climbed by 11.1% year-over-year to $76.79 billion, while beating the analysts’ forecast by $980 million. Likewise at the other end of the equation, EPS of $1.55 fared better than the $1.45 anticipated on the Street.
So far, so good, so where’s the problem?
Wedbush’s Scott Devitt, a 5-star analyst rated in the top 3% of the Street’s stock pros, pinpoints two issues that rankled with investors: “(1) uncertainty related to the trajectory of Cloud revenue growth following lackluster 3Q results, and (2) incrementally lower expectations for future margin expansion as 3Q operating margin was ~60bps below consensus.”
But do these issues merit the sharp drop seen in the post-earnings session? According to Devitt, not really. Regarding the first point, Alphabet is striving to keep pace with Amazon Web Services and Microsoft Azure in the Cloud market. Although Cloud revenue experienced a 22.6% year-over-year increase, reaching $8.41 billion, it fell slightly short of consensus expectations of $8.64 billion.
That is a non-issue, says the 5-star analyst, who thinks owning Alphabet for its Cloud business is “like rooting for Michael Jordan to play baseball.” That is because the Cloud segment represents just ~11% of revenues and ~1% of operating income, compared to the main advertising business, which commands 78% of revenue and is “accelerating into 4Q, and beat 3Q expectations by more than enough to offset slower cloud growth.”
As for the second concern, operating income reached $21.34 billion (compared to $17.14 billion in the year-ago period), falling short of expectations by ~1.1%. However, leaving out non-recurring items of employee severance ($86 million), office restructuring costs ($16 million), and accelerated deprecation and rent ($207 million), Alphabet would have seen operating income reaching $21.65 billion, representing a 28.2% margin, thereby edging ahead of the Street’s call by 0.4%.
As such, Devitt thinks the downbeat reaction is unwarranted. “Our thesis remains intact,” he goes on to say, “and we continue to see a favorable setup for Alphabet with Y/Y operating margins rising and core advertising growth accelerating.”
Accordingly, Devitt reiterated an Outperform (i.e., Buy) rating on GOOGL shares along with a $160 price target, suggesting shares will climb 27% higher in the months ahead. (To watch Devitt’s track record, click here)
Devitt’s thesis gets plenty of support on Wall Street. GOOGL’s Strong Buy consensus rating is based on a mix of 29 Buys against 7 Holds. The analysts see shares delivering returns of 22% a year from now, given the average target stands at $153.42. (See Alphabet stock forecast)
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Disclaimer: The opinions expressed in this article are solely those of the featured analysts. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.
