Google Stock Is a Winner, but Upcoming Earnings Could Be a Road Bump
Global digital search giant Google (NASDAQ:GOOG) is set to report highly anticipated second quarter earnings after the bell on Monday, July 23.
I say “highly anticpated” for two reasons. One, GOOG stock sold off after its last earnings report to just above $1,000. Since, GOOG stock has rallied nearly 20% to $1,200. Clearly, big expectations are priced in.
Two, the analyst team at Goldman Sachs just lifted their price target on GOOG stock from $1,250 to $1,350, and reiterated their Buy and Conviction List ratings on the stock. The bullishness ahead of the Q2 earnings report is due to strong advertiser checks which point to upside on pricing and revenue.
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Thus, Google’s second quarter earnings report is highly anticipated. And considering the bullish lift from Goldman and the huge rally into earnings, the numbers need to be quite good in order to send GOOG stock higher.
Unfortunately, I don’t think the numbers will be good enough. Revenue growth will be strong, as always. But margins will remain a headwind. And, at current levels, GOOG stock isn’t priced for that headwind to persist.
Here’s a deeper look.
Google’s Q2 Numbers Could Disappoint
My read on the situation is that Google’s second quarter numbers won’t be enough to satisfy investors with super-charged expectations.
Goldman Sachs thinks that revenue growth will be above expectations. I don’t doubt it. This is a company with multiple secular tailwinds across digital advertising, cloud, smart home, and machine learning — the sum of which should continue to drive robust, 20%-plus revenue growth in the near-term. Also, Google hasn’t missed revenue expectations in over 2 years. That won’t change this quarter.
But, revenue growth has never been the problem for GOOG stock. Profit growth has always been the problem.
Specifically, margins have been getting killed recently due to a combination of higher Traffic Acquisition Costs (TAC) in the advertising business and super-charged investments into long-term growth businesses like mobile, cloud and self-driving. TAC growth is expected to moderate this quarter. That should boost margins somewhat. But, management reiterated on last quarter’s conference call that their focus is on investing to support long-term growth opportunities.
Therefore, big investments likely persisted this quarter. That will show up in Q2 numbers in the form of severe margin compression. Severe margin compression won’t satisfy investors who have bid the stock up 20% over the past 3 months on expectations that such margin headwinds were in the rear-view window.
Google Stock Is A Long Term Winner
GOOG stock isn’t my favorite play heading into the Q2 print. But, it is one of my favorite long-term growth investments due to the company’s broad exposure to multiple secular growth markets.
Google is the world’s leading digital advertiser. Digital advertising remains a secular growth industry. As more and more content goes from traditional mediums to internet mediums, more and more ad dollars will flow into Google’s ad platforms. Alone, Google’s digital ad business should sustain 10%-plus revenue growth over the next 5 years.
But, Google is so much more than just digital ads. The company is at the forefront of the global machine learning, smart home, and AI revolutions. Thanks to its robust data-set from billions of Google searches, the company projects to remain a leader in these big growth markets for the foreseeable future. Also, the company is behind a rapidly growing cloud business with secular growth drivers through accelerated cloud services adoption. And the company’s self-driving unit, Waymo, could one day yield billions of dollars in revenue through a self-driving ride-hailing service.
Put it all together, and this is easily an 18-20% revenue growth company going forward. Assuming operating margins eventually normalize towards 25% as big investments peel back over time, and Google can realistically do about $80 in earnings per share in 5 years. A historically average 20 forward multiple on that implies a four-year forward price target for GOOG stock of $1,600.
Bottom Line on GOOG Stock
Long-term, GOOG stock is a big time winner thanks to broad exposure to multiple secular growth markets. But, near-term, GOOG stock looks susceptible to weakness as Q2 margins will likely come in lighter than expected. That could short-circuit what has been multi-month rally in the stock.
Such near-term damage, though, will likely be minimal, and any substantial dips in the stock should be viewed as an opportunity to add more to one’s position.
As of this writing, Luke Lango was long GOOG.
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