Alphabet (GOOG/GOOGL) reported mixed results relative to consensus expectations for 1Q18.  The results also contained a lot of noise due to accounting requirements.  The key takeaways for Northlake are that the company is still growing quite rapidly given its size, while the cost of sustaining the growth is rising.  We emphasize the long-term opportunity over the short-term costs especially since (1) revenue growth in core search remains strong, and (2) opportunities in self-driving cars, cloud, and YouTube are large.  The bottom line is we think GOOG is correct to invest for the future and that sustaining 20% revenue growth will eventually be rewarded by investors as expense growth moderates.

2019 and 2020 estimates for EPS are coming down slightly with operating expense and capital expenditure growth exceeding still vibrant revenue growth.  With Wall Street nervous about large cap technology stocks for the first time in a while due to the privacy issues and a possible investment landscape shift to late economic cycle concerns (interest rates and inflation), GOOG shares are trading down almost -4% in response to the earnings.  We expect to see a better balance between revenue and expense growth beginning in 2Q18, which should limit downside.

GOOG shares trade at around 21 times slightly lower 2019 estimates.  This is an attractive level for a large cap company that continues to post 20% growth.  The P-E ratio looks even more attractive when considering the company has over $100 per share in net cash on its balance sheet and several high growth businesses such as Waymo (self-driving car technologies) and cloud that are losing money or under earning relative to their large potential.  We also see YouTube as undervalued within the GOOG market capitalization when comparing it to Netflix and other video centric companies.

If we have one significant complaint, it is that GOOG provides limited information about the company’s different businesses.  This has become a widely held complaint on Wall Street.  We see upside of 20% in the shares but we suspect investors will want to see signs of improved balance between revenue and expense growth and/or better disclosure before the shares begin another move higher.  Northlake is willing to wait.

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.  GOOG/GOOGL is a net long position in the Entermedia Funds.  Steve is portfolio manager and managing partner of Entermedia, long/short equity hedge funds focused on media, entertainment, leisure, communications, and related technologies.