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Stock Analyst Update

Alphabet Sees Strong Growth; Shares Fairly Valued

We're raising our fair value estimate for Alphabet after the firm's better-than-expected quarter.

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 Alphabet (GOOG) (GOOGL) continued its strong 2018 performance with second-quarter top and bottom line (excluding the latest fine from the European Commission, or EC,) coming in higher than our projections and consensus. 

Revenue growth was driven mainly by Google's advertising and other revenue, including the Google Cloud Platform. With traffic acquisition cost rate growth decelerating, operating margin declined slightly less than our assumption. We adjusted our Alphabet projections higher for our five-year forecast period, resulting in an 8% increase in our fair value estimate to $1,300 per share. 

The market appears to be welcoming Alphabet's earnings results as the stock is up more than 3% in after-hours. Alphabet shares continue to trade in 3-star territory; however, we would be buyers of this wide-moat and high uncertainty name on any pullback.

Total revenue came in at $32.7 billion, up 26% year over year, driven by growth in ad and other revenue. Google ad revenue of $28.1 billion during the quarter was up 24% year over year as online ad spending, mainly on mobile devices, continues to grow. Advertisers are also purchasing more online video ad inventories, from which Google's YouTube benefits. We estimate that ads sold by YouTube account for 10%-15% of the firm's total ad revenue.

While Google is benefiting from more usage of mobile devices by consumers, the firm is also paying higher traffic acquisition costs, or TACs. We were pleased that overall TAC rates stabilized a bit in the second quarter to 22.9%, up only 40 basis points from last year. While this is not indicative of any possible decline in TAC rates, growth in those rates are likely to decelerate, according to management.

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Ali Mogharabi does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.

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