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Alphabet's Top-Line Growth Rebounds

Ali Mogharabi (ali.mogharabi@morningstar.com)

Reacceleration in Alphabet's GOOG top-line growth driven by strength in ad and cloud revenue, combined with further stabilization in traffic acquisition costs, resulted in second quarter top- and bottom-line coming in above consensus expectations. Alphabet is certainly maintaining its dominance in the online advertising space while continuing to make headway in the cloud market. We made only slight adjustments to our model and are maintaining our $1,300 per share fair value estimate on this wide-moat name. In reaction to second-quarter results, the stock has jumped nearly 8% in after-hours and is approaching our fair value estimate. However, like its peer, Facebook, we think various regulatory risks faced by Alphabet may limit the stock's upside. Since becoming a 4-star stock in early June, the stock has gained over 9% and is now trading in 3-star territory. We recommend a slightly wider margin of safety before investing in this high uncertainty name.

Alphabet reported total second-quarter revenue of $38.9 billion, up 19% year over year and an improvement from the previous quarter's 17% growth. According to the firm, such growth was driven mainly by the bounceback in ad revenue and further strength in cloud. While traffic acquisition costs as a percentage of ad revenue were lower than last year, the continuing increase in YouTube content acquisition drove gross margin 190 basis points lower to 55.6%. With slightly higher year-over-year R&D investments as a percentage of revenue, Alphabet's operating margin came in at 23.6%, around 55 basis points lower than the year-ago quarter.

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