Alphabet (GOOG/GOOGL) reported another outstanding quarter led by search advertising along with solid contributions from YouTube and Cloud.  Profit margins were better than expected.  All this good news was juiced by the announcement of a 20-for-1 stock split that will become effective in July.  We see little economic value in stock splits and history suggests the announcement of the split provides almost all the incremental stock upside.  In this case, however, there could be some sustained upside from increased retail demand for the shares at the adjusted stock price (presently a little under $150) and the possibility that the lower stock price leads to the shares being added to the Dow Jones Industrial Average.  The Dow is a price-weighted index so it seems likely Alphabet shares have not yet been added due to the disproportionate weight the stock would have at its current pre-split price.

Stock Reaction:  Given all the good news, GOOG/GOOGL shares are rising sharply, up about 8%.  The shares almost reached an all-time high after recovering most of the January decline.

Earnings Analysis:  Overall revenue growth was north of 30% as the company continues to benefit from greater digital engagement by businesses and users since the pandemic began.  There is an argument to be made that some of this incremental growth will settle back as the global economy continues to return to normal activity levels.  However, the company is clearly benefitting from continued investment in its advertising products and services through artificial intelligence and machine learning.  Google is continually making it easier to buy advertising on its platforms while enhancing the value and effectiveness of the advertising.  The company is somewhat insulated from privacy concerns that are more impactful for social media and has probably gained some market share.

Alphabet also continues to show much better expense management resulting in operating leverage on the fast top-line growth.  This is perhaps the biggest change at the company over the last several years as previously operating margins regularly disappointed.  Currently, there is some benefit coming from temporary cost savings related to COVID but after a multiyear string of good operating margins, this aspect of the Alphabet story appears to be a secular change for the better.  This will be critical as management has noted that expense growth should pick up in 2022 at the same time that tough comparisons lead to meaningful deceleration in revenue growth. 

Target Price:  Following the big recovery in the shares after earnings, we think upside could be limited for the next quarter or two as investors wrestle with the drop in top-line growth from over 30% to the mid to upper teens.  With expenses picking up, profit margins could be slightly lower.  This combination could lead investors to take a wait-and-see attitude regarding the post-pandemic secular growth rate.  Northlake is confident that the growth rate in the next few years will be higher than what investors expected back in 2019.  The pandemic has driven some permanent changes in behavior.  Equally important, management’s investment in AI is driving continual improvements in the company’s advertising products, driving the secular market share gain within digital and from traditional advertising such as TV.

We see the shares offering upside to $3,100-$3,200 on 2022 earnings in the next couple of quarters while investors digest the upcoming growth deceleration.  As we look out to 2023, we still believe the stock can reach $3,500-$4,000 if our thesis of improved secular revenue and profit growth proves correct.  Importantly, these targets are not based on aggressive valuation multiples as GOOG/GOOGL shares are presently trading at a P-E of 23 and an EBITDA multiple of 15. Given the scarcity of large cap companies growing 15-20%, the stock is not expensive. 

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.