Alphabet (GOOG/GOOGL) reported another outstanding quarter with growth in revenues, operating income, and EPS easily beating elevated Wall Street estimates.  This is the third straight quarter where GOOG has beaten Wall Street estimates.  Importantly, overall revenue growth accelerated to 32% on a constant-currency basis from the impressive 23% growth rate in 4Q20.  The string of better-than-expected reports suggests that the surge in digital commerce during the pandemic has at least an element of permanence rather than just a pull forward of previously expected demand.  In addition, March was just the beginning of a rebound in travel and hospitality advertising spending as the pandemic begins to wane.  Earnings estimates for 2021 thru 2023 are rising 10-15%.  Higher estimates plus greater confidence in the sustainability of growth boosts our target for GOOG/GOOGL shares to $2,900 as we look ahead to yearend and expected 2022 results.

During 1Q21, GOOG saw accelerating growth in the core Search business and Google Play on Android (the equivalent of Apple’s App Store).  Search only benefitted for one easy month of comparisons to the start of the pandemic in March 2020.  Strength at Play even as consumers in many parts of the world began to resume normal activity is a good sign that the shift to a digital-centric lifestyle is permanent.  Alphabet’s fastest growing businesses are YouTube and Cloud.  Both reported growth in the upper 40% range consistent with 4Q20.  YouTube is especially impressive and appears to have moved to higher growth profile as advertisers seek to reach its massive audience of the prized 18-49 year-old demographic.  Management seems very confident that YouTube can sustain growth by gaining market share thanks to investments in AI and machine learning that are raising the ROI for advertisers.

1Q21 was not just a big quarter for the top line.  Margins expanded sharply led by the advertising businesses.  Google Cloud also cut its losses almost in half, benefiting partially from a new lower rate of depreciation for servers.  The company has a mixed record on profit margins but recently there is steady improvement.  On the conference call following the earnings report, management expressed confidence that operating expenses would remain controlled in 2021 even as revenue accelerated against easy comparisons and certain expense lines that benefitted from the pandemic begin to return to normal.

Capital allocation has been another area where Alphabet has often been criticized.  However, capital spending has recently been steadier and the company has begun large share buybacks.  The company has well over $100 billion in net cash on the balance sheet and will produce free cash flow north of $70 billion this year.  Along with earnings, a new $50 billion buyback program was announced.  Shares outstanding declined year-over-year again this quarter. A hallmark of Apple’s historic stock market run has been steady and large return of capital to shareholders.  Alphabet seems to be moving in this direction even as it continues to invest heavily in growth.

Prior to the quarterly report, our valuation analysis suggested that GOOG/GOOGL shares were nearing full value on 2021 estimates and had limited upside on 2022 estimates.  We were comfortable with the shares still due to what we believe are conservative assumptions in our valuation framework.  We also thought there was upside to results over the next few years.  We continue to use what we believe to be conservative assumptions in calculating our target price and the magnitude of the estimate increases easily exceed what we thought was likely. 

Our new $2,900 target is based on 2022 estimates and looks out 9 to 12 months.  We continue to assume conservative valuations on Waymo and Verily, the largest of the company’s Other Bets.  We also note that Google Cloud, now nearing a $20 billion revenue run rate, is still producing losses and thus penalizes our EBITDA based valuation approach.  We compensate to a limited extent by upping our overall EBITDA multiple assumption, but the Cloud business could easily provide another $100 billion, or $150 per share, in hidden value. 

GOOG/GOOGL shares have bucked the trend for large cap growth stocks to lag the market in 2021.  The already large advance plus another 5% pop on the latest earnings report could lead to some consolidation in the share price.  This is about the only cautionary statement we can make beyond continued challenges from regulatory authorities and the usual concerns about sustaining growth in revenues and profits.

GOOG/GOOGL is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts.  Steve is sole proprietor of Northlake, a registered investment advisor.  Northlake’s regulatory filings can be found at www.sec.gov.