Shares of Alphabet (NASDAQ:GOOGL) fell off a cliff in late April after the digital search giant reported first quarter numbers that were largely unimpressive. Broadly speaking, Alphabet’s revenue growth is slowing, rapidly, while margins are still narrowing, and no one really knows when either of these adverse trends will reverse course.
Consequently, Alphabet’s Q1 numbers provided investors with more questions than answers, and that lack of clarity weighed on GOOGL stock, which dropped nearly 10% in response.
To be sure, things aren’t great at Alphabet. But, this company is still the backbone of the internet, with a digital ad business that is still growing healthily, margins that have potential to stabilize in the foreseeable future, and big future growth drivers in self-driving which have yet to yield a financial impact.
In other words, things aren’t great at Alphabet, but they are good enough to warrant buying GOOGL stock on this dip. As such, now looks like the time to get bullish — not bearish — on Alphabet shares.
Not-So-Great Q1 Numbers
Alphabet’s Q1 numbers were worrisome. Specifically, they broadly implied that growth is slowing as the company lose digital ad market share. Margins are still under pressure from a mobile shift, and profit growth is muted as a result of slowing revenue growth and falling margins.
Alphabet’s revenue rose just 19% in the period, the slowest growth rate in three years. Further, digital ads increased only 15% in the quarter, also the weakest for that business in three years. A sluggish digital ad business has become a drag on Alphabet’s overall business.
This is worrisome. All of Google’s notable digital ad peers are growing faster than Google.
GOOGL’s 15% digital ad growth rate pales in comparison to Facebook (NASDAQ:FB), which reported 26% revenue growth last quarter. Twitter (NYSE:TWTR) reported an 18% increase, Snap (NYSE:SNAP) showed 39% growth, and Amazon (NASDAQ:AMZN) posted right around 40% digital ad improvement.
The implication? After years of dominating the global digital ad market, Google is finally losing share. A few years back, it controlled roughly 43% of the global digital ad market. This year, if 15% ad revenue growth persists, Google’s market share will come in at just over 40%.
Why the market share erosion? No one really knows. But, I suspect it has something to do with the mobile shift. Quite simply, Google’s digital ad properties were built for desktop, not mobile. Facebook, Twitter, and Snap, however, were all built for mobile. As engagement has shifted to mobile, more ad dollars have migrated into those mobile-first platforms, at the expense of Google.
That means this slowdown is here to stay. It’s also here to stay against the backdrop of margins that have been consistently falling for several quarters. Overall, then, the outlook for Alphabet over the next several years isn’t the best.
Long-Term Drivers Remain Healthy
Although the outlook for Alphabet over the next several years isn’t the best, it isn’t the worst, either.
In the big picture, the long-term growth drivers supporting GOOGL stock remain healthy. Google is still the backbone of the internet. YouTube is still the number one video consumption platform in the world. The global digital ad market is still growing at a double-digit clip. The cloud business is still growing at a 20%-plus clip. TAC growth is moderating, and operating profit growth has actually improved over the past several quarters.
Meanwhile, Waymo — the company’s self-driving unit — has yet to make a material impact on the financials. But, Waymo is widely considered the leader in autonomous vehicles, and that market at scale could produce billions of dollars in revenue and profits.
In other words, Alphabet is still a very healthy company that projects as a solid double-digit revenue grower over the next several years, with potential for margin improvement as TAC growth continues to moderate. Ultimately, that won’t produce huge returns from current levels. But, it does imply that GOOG stock is undervalued after this recent sell-off.
Long term, by fiscal 2025, double-digit revenue growth on top of gradual margin improvements should drive EPS toward $100. Based on a historically normal and growth average ~20x forward multiple, that implies a reasonable 2024 price target for GOOGL stock of $2,000. Discounted back by 10% per year, that equates to a fiscal 2019 price target north of $1,240.
Thus, below $1,200 today, GOOGL stock appears undervalued.
Bottom Line on GOOGL Stock
Not all is well on Alphabet Street. But, enough is well to warrant buying GOOGL stock on this big dip. So long as the company maintains its leadership position in the secular growth digital ad market and the margin trend continues to improve, Alphabet stock should rebound from this sell-off.
As of this writing, Luke Lango was long GOOG, FB, and AMZN.
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