Going Into Earnings, Is Alphabet Stock a Buy, a Sell, or Fairly Valued?

Alphabet GOOG/GOOGL is set to release its first-quarter earnings report on April 25. Here’s Morningstar’s take on what to look for in Alphabet’s earnings and stock.

Key Morningstar Metrics for Alphabet

• Fair Value Estimate: $171.00
• Morningstar Rating: 3 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

Alphabet Earnings Release Date

• Thursday, April 25, after the close of trading

What to Watch for In Alphabet’s Q1 Earnings

• The status of artificial intelligence: What is Google doing, and where is it at in ensuring there’s no repeat of the publicity fiasco around the Gemini launch in February (full of image generation and text responses that were historically inaccurate or deemed biased)? Maintaining broad appeal is key to retaining the scale advantages underlying the success of the firm’s search business. We’ll also look for any updates to the firm’s thinking around including generative AI in the search product and how it will sell ads against that service.
• Cost cutting and margins: What is the outlook for operating expense reductions in 2024 after the cutting last year? Are capital spending needs continuing to move higher as the firm builds out infrastructure to support AI and cloud growth?
• The status of the ad market: Is demand for digital advertising continuing to accelerate? After bottoming in late 2022, the digital ad market has bounced back extremely quickly, with growth accelerating each quarter throughout 2023. Has that momentum cooled?

Fair Value Estimate for Alphabet

With its 3-star rating, we believe Alphabet’s stock is fairly valued compared with our long-term fair value estimate of $171 per share, which is equivalent to a 2024 enterprise value/EBITDA ratio of 15. We expect slight margin pressure in 2024, given the firm’s continued investments in growth initiatives (mainly AI) which require higher research and development. We look for margin improvement in 2025-28, thanks to better generative AI search monetization and faster growth in the cloud driven by wider adoption of generative AI. Our model assumes a five-year compound annual growth rate of over 10% for total revenue and a five-year average operating margin of nearly 29%.

We expect advertising revenue to remain over 70% of Alphabet’s total revenue, driven by continuing growth in digital ad spending, albeit at a much slower rate than historically. We model 6.5% ad revenue growth for 2024 due to slower expected economic growth than in 2023. We have estimated total Google ad revenue of $253 billion in 2024 and $272 billion in 2025. We think YouTube will contribute 13.6% of Google’s advertising revenue in 2024 (up slightly from 2023) and more than 14% in 2025. YouTube growth should benefit from its impressive reach and usage frequency, plus its video-only content format, which is attractive to brand advertisers.

Read more about Alphabet’s fair value estimate.

Economic Moat Rating

We assign Alphabet a wide moat, thanks to durable competitive advantages derived from the company’s intangible assets and network effect.

We believe Alphabet holds significant intangible assets related to overall technological expertise in search algorithms and artificial intelligence (machine learning and deep learning), as well as access to and accumulation of valuable data for advertisers. We also believe Google’s brand is a significant asset. “Google it” has become synonymous with searching, and regardless of actual technological competency, the firm’s search engine is perceived as being the most advanced in the industry. While Microsoft’s MSFT Bing is attempting to dethrone Google with AI technology from OpenAI, we think the firm can defend its dominance in search with its own AI technology, some of which OpenAI’s products are based on.

Read more about Alphabet’s moat rating.

Financial Strength

Alphabet has a strong balance sheet, with cash and cash equivalents of $111 billion versus total debt of only $13 billion as of the end of 2023. The company also has a $4 billion revolver with no outstanding balance. Over 60% of the company’s cash and cash equivalents are held outside the United States.

Read more about Alphabet’s financial strength.

Risk and Uncertainty

Our Uncertainty Rating for Alphabet is High. While we remain confident that Google will maintain its dominant position in the search market, a long-lasting downturn in online ad spending could harm Alphabet’s revenue and cash flow. On the other hand, positive returns on investments in cloud and moonshots could considerably increase our fair value estimate.

Google faces antitrust pressure and various claims and investigations from different regulatory agencies regarding search bias and its overall market dominance in online advertising. Some governments may forbid access to some of Google’s properties, which could result in lower user growth and monetization. Similarly to Meta, Google faces limitations on mergers and acquisitions as the US and other countries attempt to lessen its dominance in advertising and the overall internet market.

Read more about Alphabet’s risk and uncertainty.

GOOG Bulls Say

• As the number of online users and usage increase, so will digital ad spending, of which Google will remain one of the main beneficiaries.
• Android’s dominant global market share of smartphones leaves Google well-positioned to continue dominating mobile search.
• The significant cash from the Google search business lets Alphabet focus on innovation and long-term growth opportunities in new areas.

GOOG Bears Say

• There is little revenue diversification within Alphabet, as it remains heavily dependent on Google and search advertising.
• Alphabet is allocating too much capital toward high-risk bets, which face a very low probability of generating returns.
• Google’s dominant position in online search is not durable, as more companies and regulatory agencies are contesting the methods through which the company has been extending its leadership.

This article was compiled by Sokhoeun Noeut.