Advertising Revenue, Cloud Growth Boost Google

Alphabet handily beat our third-quarter 2017 top- and bottom-line expectations as YouTube and cloud drove strong double-digit growth in advertising and other revenue. While cost-per-click continued its decline, it was more than offset by growth in ad engagements, or paid clicks, which demonstrates the firm's strong network effect benefiting both users and advertisers.

We believe healthy growth in Google's advertising revenue is no longer just driven by the ongoing digital ad transition onto mobile devices, but also by an increase in video content, which pushes demand for video advertising higher. In our view, YouTube is the main beneficiary of this trend. We believe growth in YouTube advertising and subscription revenue will contribute more to maintain Google's strong double-digit ad revenue growth throughout the next five years.

On the cloud front, investments made by Google are bearing fruit as growth in cloud is helping Alphabet make further headway toward revenue diversification. We remain confident the firm can maintain and utilize its network effect and intangible asset moat sources to remain one of the main players not only in digital advertising but also in cloud.

Alphabet's better than expected third-quarter performance prompted us to increase our projections for 2017 and beyond, resulting in an increase in our fair value estimate to $1,100 per share from $1,030 per share. Alphabet shares remain in 3-star territory, and we recommend a wider margin of safety before allocating capital toward this wide-moat name.