Alphabet (GOOG/GOOGL) reported better than expected earnings with revenues, expenses, and EPS all coming in ahead of expectations.  The revenue upside was especially impressive given the turmoil in internet and mobile advertising caused by Apple’s privacy initiatives.  Google did not escape completely unscathed as YouTube ad growth was a few percent less than expected (although still more than 40%).  Google Search was exceptionally strong and more than made up for YouTube and a slight deceleration in growth at the company’s Cloud segment.  Google is less impacted by Apple’s privacy changes since Search provides more first-party data the company’s advertisers can use to still reach consumers on a user basis.  Search also is benefitting from a rebound in verticals sensitive to COVID reopening such as travel and hospitality.  Retail is also holding up well and is probably Google’s largest category.  Facebook and Snap also have big retail presence but the ads they sell go purely to ecommerce.  Google is an omnichannel ad buy for retailers that are now seeing renewed strength in store level sales.

Stock Reaction: GOOG/GOOGL shares are up 6% and hitting new all-time highs today following last night’s earnings report and conference call.  This is in stark contrast to Facebook, Snap, and other digital advertising stocks that traded down sharply after reporting and sit 15-20% or more below their all-time highs reached as recently as two months ago.  Alphabet was already the best performing internet stock in 2021, up 60% prior to today’s gain.  The 3Q21 report is a clear endorsement of the 2021 stock performance.

Earnings Analysis: Search led the way, more than making up for slight shortfalls relative to expectations at YouTube and Cloud.  YouTube took a small hit in its direct response ad sales due to Apple’s privacy changes.  Cloud decelerated slightly to mid-40% growth but management noted continued strength in the most important large enterprise portion of the business.  Perhaps most impressive in the quarter was the company’s operating profit margin.  Management has been showing much improved cost controls since the arrival of CFO Ruth Porat in 2015.  Alphabet operating margins are higher now than pre-pandemic.  Management suggested continued investment was coming to support revenue growth but given multiple chances to push back on the idea that margins had reached a new higher level, Ms. Porat deferred.

Target Price: After slightly tweaking our valuation assumptions and rolling forward to 2022 estimates, our new target for GOOG/GOOGL shares is $3,200, up $200 from prior levels based on 2021 estimates.  This leaves about 12% upside after today’s big gains.  Management did caution that comparisons really begin to toughen in 4Q21 and that will continue through 1H22.  Furthermore, despite the confidence expressed on profit margins, management noted there is some spending that was eliminated during the pandemic that will come back onstream over the next few quarters.  These factors contribute to our decision to keep the valuation multiple in check despite Alphabet appearing to distance itself from peers on multiple financial and operating metrics.  Should the next couple quarters go smoothly, we can switch our focus to 2023 and targets in the range of $3,5000 to $4,000.

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.  DIS is a net long position in the Entermedia Funds.