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

Alphabet GOOGL is set to release its fourth-quarter earnings report on Jan. 30, after trading hours. Here’s Morningstar’s take on Alphabet’s earnings and stock.

Key Morningstar Metrics for Alphabet

• Fair Value Estimate: $161.00
• Morningstar Rating: 3 stars
• Morningstar Economic Moat Rating: Wide
• Morningstar Uncertainty Rating: High

What to Watch for In Alphabet’s Q4 Earnings

• Alphabet stock increased more than 58% in 2023 as the firm’s network effect with its core advertising business remained solid, and hesitancy among advertisers lessened as YouTube and search revenue growth accelerated late in the year.
• While search may be facing increasing competition, such as chatbots for searching or the likes of Bing, we expect an improvement in the monetization of YouTube Shorts to help the site’s overall advertising revenue.
• On the artificial intelligence front, demand will likely drive growth in Google’s cloud business. We believe reduced economic uncertainty, combined with the necessity of AI to operate more efficiently, will bring in more cloud clients and increase client usage.
• The favorable impact of the further headcount reduction in January 2024 (which will likely continue) on the bottom line will probably be seen in the second half. While the firm will continue to prioritize investments in AI, it will also focus on increasing efficiency.

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.

Our fair value estimate for Alphabet is $161 per share, equivalent to a 2024 enterprise value/EBITDA ratio of 17. We look for margin improvement in 2024-27 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 nearly 11% for total revenue and a five-year average operating margin of 24%.

We expect advertising to remain over 70% of Alphabet’s total revenue, driven by continuing growth in overall digital ad spending, albeit at a much slower rate than what’s been seen historically. We have estimated a total ad revenue of $247 billion for Google in 2024. We think YouTube will contribute about 14% of this revenue. YouTube growth should benefit from the site’s impressive reach and usage, plus its video-only content format, which is attractive to brand advertisers.

Read more about Alphabet’s fair value estimate.

Alphabet Historical Price/Fair Value Ratio]

Ratios over 1.00 indicate when the stock is overvalued, while ratios below 1.00 mean the stock is undervalued.

Economic Moat Rating

We assign Alphabet a wide moat, thanks to durable competitive advantages derived from its intangible assets, as well as a network effect.

We believe Alphabet holds significant intangible assets related to overall technological expertise in search algorithms and AI (machine learning and deep learning), as well as access to and accumulation of data that is deemed valuable to advertisers. We also believe that Google’s brand is a significant asset. “Google it” has become eponymous with searching, and regardless of actual technological competency, the firm’s search engine is perceived as being the most advanced in the industry. While with Microsoft’s 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.

In our opinion, Alphabet’s network effects are derived mainly from its Google products, such as Search, Android, Maps, Gmail, YouTube, and more. Ultimately, we view Google’s network as heterogeneous. All its products give it a massive consumer base that allows it to collect data. With its rich collection of data and large user base, Google can offer the best return on investment for advertisers and build a growing network of advertising customers. Each new ad and advertiser improves the efficiency of Google’s programmatic advertising offerings, allowing the firm to better monetize the network.

Read more about Alphabet’s moat rating.

Risk and Uncertainty

Our Morningstar Uncertainty Rating for Alphabet is High, primarily the result of high dependency on continuing online advertising growth. 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 its revenue and cash flow, resulting in a lower fair value estimate. On the other hand, positive returns on the firm’s investments in cloud and moonshots could considerably increase our fair value estimate.

The firm’s high dependence on user behavior data also represents an environmental, social, and governance danger, mainly due to risks related to data privacy and security, which could affect not only Google’s advertising business but also users’ trust in its products, as data can be misused.

Read more about Alphabet’s risk and uncertainty.

GOOGL 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 generating top-line growth as search traffic shifts from desktop to mobile.
• The significant cash generated from Google search lets Alphabet focus on innovation and the long-term growth opportunities new areas present.

GOOGL Bears Say

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

This article was compiled by Quinn Rennell.