Article Thesis
Alphabet Inc. aka Google (NASDAQ:GOOG, NASDAQ:GOOGL) reported its first-quarter earnings on Thursday. The company generated strong results and remains inexpensive, which is why I believe that being long Alphabet is a good idea.
Past Coverage
I have covered Alphabet several times here on Seeking Alpha, most recently in January when the company reported its fourth-quarter earnings results. In this article, I argued that Alphabet was a strong investment due to the market underpricing its growth. Since then, shares have risen slightly. In today’s article, I will focus on the company’s first-quarter results and what they mean for the company and the stock going forward.
What Happened?
Alphabet reported its first-quarter earnings results on Thursday, April 25th afternoon after the market had closed. The company’s headline results can be seen in the following screencap:
GOOG results (Seeking Alpha)
Alphabet was able to generate revenues of $80.5 billion, which was up nicely compared to the previous year’s period. While one can expect above-average growth rates from tech companies, due to the industry’s better growth rate relative to the overall economy, Alphabet’s 15% revenue increase nevertheless was quite compelling, I believe. After all, Alphabet is a massive and established company; thus it is far from “normal” for a company like Alphabet to grow at a mid-teens rate.
When we consider the fact that currency rates were a headwind for the company during the period and that currency-adjusted growth was even better, at 16%, that’s all the more reason to be happy about GOOG’s recent performance. The analyst consensus estimate was beaten easily, making for a positive surprise for shareholders.
Alphabet’s profits came in way higher than expected, beating the consensus estimate by a hefty 25% — analysts continue to underestimate the company, with GOOG now having a track record of five quarterly earnings beats in a row.
The market liked these results a lot (new shareholder return announcements also played a role), sending Alphabet’s shares higher by 13% at the time of writing.
Alphabet’s Results: Strong Operational Performance
One day before Alphabet, Meta Platforms (META) reported its first-quarter results. The company showed strong revenue growth and excellent earnings growth on the back of operating leverage. I thought that there was a good chance that Alphabet would report something similar, and that is precisely what happened.
Alphabet showcased compelling business growth, driven by appealing results across most of its divisions. The most important and oldest business unit, Search, showed revenue growth of 14%. I believe that this is a strong result — after all, billions of consumers around the world have been using Google to search the internet even before the most recent quarter, and thus one could have imagined that this was a rather mature business. But the company nevertheless was able to show strong growth in this space. Pricing plays a role, as more and more advertisers see the value of having their ads on Alphabet’s websites, allowing for price increases over time. Pricing power appears to be quite robust, as Alphabet was able to generate highly appealing growth during the first quarter even though economic growth in the United States, Alphabet’s home market, was rather muted.
The YouTube ads business saw the best growth rate among the major non-cloud business units, generating 21% revenue growth compared to the previous year’s quarter. Over the last couple of quarters, there was some talk and uncertainty about Alphabet’s ad blocker policy and how this could impact users — but judging from the results the company just reported, the move was great for the company. After all, revenue growth is explosive, considering the fact that YouTube is a well-established and large business already.
Google Cloud, which is one of the major cloud computing players around the world, saw very nice growth as well, with revenues rising by 28% compared to the previous year’s quarter. This was also slightly more than during the previous quarter when year-over-year growth came in at 26%. Momentum thus seems to be on Alphabet’s side, which could bode well for the performance of the cloud computing segment during the remainder of the year. With close to $10 billion in quarterly sales, Google Cloud has not only turned into a strong grower in relative terms, but it has also become a major source of overall absolute revenue growth for the company.
Revenue growth is good, but earnings growth is even better. And Alphabet delivered quite a bit of earnings growth in the first quarter. YouTube, the Search platform, etc. have high fixed costs for hosting, maintenance, etc., and require high-earning engineers to be maintained. But when additional users are added, or when price increases on ads drive revenue growth, these additional revenues do not cause substantial additional costs. As long as the business is growing, operating leverage thus allows Alphabet to grow its profits at an above-average pace.
During the pandemic, Alphabet and some other tech companies over-hired. As a result, costs grew too quickly, but GOOG has corrected that already and has tighter cost controls now. Thanks to operating leverage and its nice revenue growth rate of 15%, Alphabet was able to grow its operating profits by a hefty 47% compared to the previous year’s quarter. While META’s growth during Q1 was even better, Alphabet’s profit growth was highly compelling and well-received by shareholders.
On the profit side, things also looked great at Google Cloud. While the unit was profitable last year, it only was barely so, with a sub-$200 million profit in Q1. Contrast this to this year’s first quarter, where the unit generated a $900 million profit. It seems likely that ongoing business growth for the cloud segment will continue to drive substantial profit growth in the future. It can be expected that Google Cloud will become a larger and larger profit contributor going forward, thanks to the unit’s above-average revenue growth rate in combination with what looks like great operating leverage for the cloud business.
On a net basis, earnings came in at $23.7 billion, or 57% higher year-over-year, meaning Alphabet is close to a $100 billion-a-year profit pace. Thanks to the impact of buybacks, earnings per share growth was even better than that, with the bottom-line being up 62% over the last year.
Amped-Up Shareholder Returns
It is normal for growth companies to invest significant sums back into the business, but eventually, cash flows can become so large that a company has to find a new way to utilize its funds to drive shareholder value. Apple (AAPL) decided to return more cash to its owners around a decade ago, while META decided to offer dividend payments one quarter ago. Alphabet seemingly realized that this move by META was well-received and has now done the same — we’re getting dividends from Alphabet!
The New Dividend
The company declared a $0.20 per share dividend, which pencils out to $0.80 per year and a dividend yield of around 0.5%. That is far from high, of course, but a company has to start somewhere. And when we consider that the payout ratio is in the 10% range and that Alphabet will likely continue to grow its profits at a nice pace going forward, there is a lot of potential for future dividend growth.
For a dividend growth investor who does not require a high yield today, Alphabet could thus be a viable choice. The new dividend also means that Alphabet will now be eligible for inclusion in some ETFs that do not buy non-dividend-paying stocks, which could result in some additional demand for GOOG’s shares in the coming weeks.
Share Repurchase Program
On top of the dividend announcement, Alphabet also announced a $70 billion share repurchase program. This covers a little more than 3% of the company’s share count and could be done in a year purely out of the company’s massive free cash generation ($17 billion during Q1) — even before accessing the $108 billion cash pile on GOOG’s balance sheet.
Alphabet’s shares are far from expensive, trading at around 23x forward net profits. For a leader in a growth industry with strong momentum and a fortress balance sheet, that isn’t expensive, I believe. I thus like that Alphabet plans to buy back shares at a nice pace in the coming quarters, as this should drive shareholder value and since the company has more than enough cash between its free cash generation and its existing cash position.
Takeaway
Buying Alphabet a year ago was better than buying it today, as Alphabet has experienced substantial gains in that time frame. That being said, the company remains attractive today, and its most recent quarterly earnings report was all-around positive. Business momentum is strong, especially for YouTube and the cloud business, cost controls remain tight, operating leverage is working nicely, and amped-up shareholder returns are the icing on the cake. I remain bullish on Alphabet stock and am happy with my long position.
