Google: Rally Coming Soon (NASDAQ:GOOG) | I’m looking for Alpha

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Justin Sullivan

Going into Google’s (NASDAQ:GOOG) Q1 2023 (NASDAQ:GOOGL) report, I argued that the tech giant is likely to beat analyst estimates in both revenue and earnings, which could catalyze a rally. Now, after Google actually beat analyst estimates, I can’t wait for the next topic of my thesis to unfold: a rally above $150 a share.

Reflecting on Google’s strong earnings report coupled with a firm commitment to cost control and investment in AI, I review my EPS projections for Google through 2025; and now I calculate a fair implied target price of $165.77 per share.

For reference, Google’s stock is outperforming the broader market YTD by a factor of x2. Since the start of 2023, GOOG shares are up nearly 21%, versus a less than 10% gain for the S&P 500 (SPY).

I’m looking for Alpha

Google first quarter 2023 results

After the market close Wednesday, Google reported results for the first quarter of 2023, beating analyst consensus estimates for both revenue and earnings. In the period January through the end of March, the conglomerate that owns the world’s most popular search engine reported revenues of approximately $69.8 billion, up from $68 billion in the same period a year earlier (growth of 3 % year over year and significantly above the estimated $68.8 billion per consensus (~$1 billion topline beats).

In terms of profitability, Google’s operating income was $17.4 billion, down nearly 15% from Q1 2022 on a margin contraction of 500 basis points (operating margin of 25% in the first quarter of 2023 compared to 30% in the first quarter of 2022). Google’s after-tax net income was approximately $15.05 billion ($1.17 per share), down about 5% year over year, but beating analyst estimates by nearly ~1. 3 billion.

Google reports Q1 2023

Notably, Google’s first-quarter pace was supported not only by stronger-than-expected advertising activity, which defended a top line and operating profit in line with Q1 2022, but also by excellent performance of Google’s cloud, where revenues increased about 30% year over year, to about $7.5 billion and operating profits increased to a gain of $191 million, compared to a loss of $700 million for the same period of the previous year.

I’d also like to point out that Google’s profitability figures for Q1 2023 reflect approximately $2.6 billion in “charges related to reducing our workforce and office space,” implying that without expense accounting we would not applicants, Google’s profitability for the period would have been in line with Q1 2022.

Google reports Q1 2023

Google reports Q1 2023

Reflecting on a solid first quarter 2023 performance, Sundar Pichai, CEO of Alphabet and Google, commented:

We’re pleased with our business performance in the first quarter, with search performing well and momentum in the cloud. We have introduced important product updates anchored in information technology and artificial intelligence. Our North Star is providing the most useful answers for our users and we see huge opportunities ahead, continuing our long track record of innovation

And Google CFO Ruth Porat added that:

Resiliency in search and momentum in the cloud drove consolidated first quarter revenue of $69.8 billion, up 3% year over year or 6% in constant currency. We remain committed to delivering long-term growth and building the ability to invest in our most attractive growth areas by re-engineering our cost base.

Additional takeaway Q1

During Google’s Q1 2023 analyst conference call, much of the management discussion revolved around Google’s opportunities and advances in AI, specifically how AI is and could be used to improve both productivity internal and new commercial products. With that framework, management highlighted plans to more seamlessly integrate LLM experiences into core research, rather than making it a complementary product alongside Bard. In my opinion, this decision implies Google’s focus on AI as a core component of multiple Google products and services.

On OPEX discipline, Google’s management has remained committed to slowing the pace of hiring and restructuring the company’s cost base. The goal is to ensure that cost growth does not outpace revenue growth in the future. But in line with my pre-Q1 2023 thesis, I believe Google has a significant edge to expand margins against the backdrop of further workforce reductions, as the search giant lags behind the discipline exhibited by Meta Platforms (META) .

A note on share buybacks

In light of Google’s strong first-quarter results, investors probably aren’t surprised that Google continues to buy back shares at an attractive pace: In the January quarter, Google repurchased $14.6 billion worth of shares, compared to $13.3 billion in the first quarter of 2022. This move clearly highlights Google’s management’s confidence in its financial stability and growth prospects, and may serve to further boost investor confidence in the company. Additionally, with a substantial cash and securities reserve of $115.1 billion as of the close of Q1 2023, Google is in an excellent position to continue to repurchase shares: On April 19, 2023, for reference, Google authorized the repurchase of additional shares, up to $70.0 billion in value of its Class A and Class C shares.

Ratings Update: Increase TP

Reflecting on Google’s robust Q1 2023 report, I update my EPS expectations for Google through 2025: while I now lower my 2023 estimates to a range of $5.2 to $5.6, down from $6.01 against the backdrop of the disciplinary management of group-wide OPEX and margin expansion for Google’s cloud, I raise my EPS expectations for 2024 and 2025, respectively, to $7.3 and $7.75 .

I continue to peg a terminal growth rate of 4.5% (one percentage point higher than estimated nominal global GDP growth), as well as a cost of equity of 9%.

Given the EPS updates as highlighted below, I now calculate an implied fair price per share for Google of $165.77/share, estimating approximately 50% upside.

financial data of the company; EPS estimates by the author; Author’s calculation

The updated sensitivity table is also below

financial data of the company; EPS estimates by the author; Author’s calculation

Risks

Google investors should be aware of the following two sentiment risks: First, part of Google’s appeal is supported by the hype surrounding artificial intelligence. That said, AI technology/commercialization may be developing at a much slower pace than anticipated. Or in general, the potential of AI (for Google) may turn out to be less impressive than expected. Second, much of Google’s current share price volatility is driven by investor sentiment towards risk and growth assets. Therefore, investors should expect price volatility even if Google’s business outlook remains unchanged.

Conclusion

In line with my expectations, Google reported a solid Q1 2023, beating analyst estimates in both revenue and earnings. Now, in line with my fundamental long-term thesis that Google runs one of the stickiest and most profitable business models in the tech/communications industry, I am excited about the likelihood of a share price appreciation, as I see multiple arguments to support it. of the rally. Specifically, I would like to point out the following: 1) Research monopoly and competitive moat support long-term value accumulation, 2) Upward earnings due to ad business improvement, OPEX discipline and margin expansion of Google’s cloud, 3) the buyback bonanza continues to support the stock price, 4) Google’s work with AI can capture new business opportunities and revenue streams (think of it as a call option free implied embedded in the title) and 5) Google is inherently underrated.

After the Q1 2023 report, I update my EPS expectations for Google through 2025; and now I calculate a fair implied target price of $165.77 per share. I reiterate a “Buy” rating.

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