On July 23, Google’s parent company, Alphabet (GOOGL), is set to report its fiscal second-quarter earnings. There is a wave of optimism surrounding GOOGL ahead of this crucial day due to ongoing tailwinds from robust advertising spending and margin growth in Google Cloud, both of which are fueled by significant advancements in artificial intelligence (AI). Despite facing mildly challenging comparisons in revenue growth, many believe that updates on AI innovations will capture investors’ attention the most, likely marking the start of a new chapter in Alphabet’s growth story.
Alphabet’s upcoming Q2 results are eagerly anticipated, with market expectations running high. Over the past three months, a substantial number of analysts—43 out of 49—have raised their forecasts for Q2, reflecting unwavering confidence in the company’s performance. To surpass Wall Street’s Q2 expectations, Alphabet needs to achieve an EPS above $1.83, marking a 27.5% rise, and reach revenues above $84 billion, indicating a 12.7% increase from the previous year. This level of expectation highlights the market’s faith in Alphabet’s ability to deliver strong results consistently.
Above all, the market will likely want to hear updates on the AI innovation wave. Last quarter, Alphabet highlighted several key points, such as consolidating its AI models like Gemini 1.5 Pro and building a strong infrastructure with efficient data centers to support advanced AI development. It also integrated AI into Search to improve user experience and engagement, which helps clear monetization paths through ads, cloud services, and subscriptions. These developments are crucial as they not only enhance user interaction but also provide new avenues for revenue generation.
Alphabet’s recent strong performance, driven by robust ad spending trends and advancements in AI capabilities, has solidified its position as a two trillion-dollar company with double-digit growth. In Q1 alone, Alphabet saw its revenues climb 15.4% year-over-year, a significant increase of over $10.75 billion compared to Q1 2023. This highlights the company’s impressive growth trajectory and its ability to capitalize on favorable market conditions. The integration of AI into its core products and services, coupled with sustained advertising demand, underscores Alphabet’s robust business model and its strategic focus on innovation.
The Google Cloud segment is particularly under scrutiny, as its performance is a key indicator of Alphabet’s growth potential. The Cloud segment reported operating margins of 9% last quarter, still much lower than Amazon’s AWS, which boasted a 37% margin. However, the progress in this area is crucial for maintaining bullish momentum. Alphabet has set ambitious targets, aiming for Google Cloud and YouTube to achieve a combined annual run rate exceeding $100 billion by this year. This commitment is underscored by significant investments in infrastructure, including nearly doubling capital expenditures (CapEx) to $12 billion in Q1 2024 compared to the previous year, despite Google Cloud operating at a loss until 2022 due to reinvestment for growth. However, management indicated that CapEx for the coming quarters is expected to be roughly at or above Q1 levels. This suggests that Alphabet is prioritizing substantial investments in infrastructure to support its growth targets.
Anticipating tough comparisons in Q2 is a natural part of the earnings cycle, especially for a company of Alphabet’s scale. Since Alphabet doesn’t provide guidance, expectations can sometimes be misaligned. Last quarter, Google’s management hinted at tougher comparisons for Q2. Alphabet’s revenue growth might be slightly lower due to the Q1 leap year benefit and the anticipated stronger impact from foreign exchange rates in Q2. These factors could present minor challenges but are not expected to overshadow the company’s overall growth trajectory.
Regarding YouTube Ads revenue, the over 20% yearly growth in Q1 was accelerated by increased spending on both brand and direct response advertising. Looking ahead, Alphabet’s management highlights two important trends: in Q1, a significant portion of advertising spend came from retailers in Asia-Pacific, a trend that began in mid-2023 and is expected to decrease in Q2; and the strong revenue growth in Q1 also reflects a comparison to a period of slower growth in the previous year’s Q1. These points are just one piece of the puzzle, but given the diverse strengths of GOOGL’s business fundamentals, these comparisons might present minor challenges currently, but they are not expected to be a surprise.
The 49% increase in value over the last 12 months, with 33% of that growth occurring in this year alone, underscores the strong trading momentum behind Alphabet stock. Google’s dominance in the advertising sector, coupled with significant growth prospects in Google Cloud driven by AI technologies, explains much of this surge. While past performance doesn’t guarantee future outcomes, historically, July—when Q2 earnings are released—has been the strongest month in terms of average returns, averaging 8.2% over the last 16 years. This highlights heightened expectations surrounding Q2 results. In contrast, August tends to show flat returns, indicating the market’s anticipation of a strong Q2 without significant surprises later on.
Since the AI boom took off, GOOGL’s post-earnings day reaction has been quite volatile over the past four quarters. The stock has either sharply risen or fallen, without much of a middle ground in the aftermath. Despite the recent strong price gains, Alphabet shares are currently trading at a forward P/E multiple of 24.5x, which is slightly below their average over the past five years. This suggests that either Alphabet was previously trading at historically high multiples, or there is potential for growth driven by advertising trends and AI in cloud computing that may still be undervalued. I personally think it’s a mix of both factors.
Wall Street analysts are extremely bullish on Alphabet stock, with the consensus rating being a Strong Buy and 32 out of 38 analysts recommending buying GOOGL. The average GOOGL stock price target is $199.97, implying upside potential of 7.2%. This reflects a strong belief in Alphabet’s continued growth and innovation capabilities.
In conclusion, Alphabet’s Q2 results are likely to please GOOGL bulls. Mildly tough comps might pose some minor challenges, but they shouldn’t overshadow the achievement of double-digit growth in both the top and bottom lines. However, perhaps the most crucial aspect regarding the stock’s reaction will depend on updates about AI. It will also hinge on how successful the Google Cloud business is in improving margins through data center efficiency and how much the integration of AI into Search is enhancing segment monetization.
The combination of robust advertising spending, advancements in AI, and significant investments in Google Cloud infrastructure positions Alphabet well for continued growth. As the company continues to innovate and expand its capabilities, particularly in AI, it remains a compelling investment opportunity.