Google Stock: Mr. Market Seems Irrational Again – Buy The Plunge (NASDAQ:GOOG)

We previously covered Alphabet Inc. (NASDAQ:GOOG, GOOGL) in August 2023, discussing its robust moat in the search engine market, cloud segment’s high growth trend, and YouTube Ads accelerating revenues thanks to the ongoing SAG-AFTRA/WGA strikes.

We rated the stock as a Buy then, since we believed that the company might be able to reclaim its leadership in the AI race, thanks to the management’s accelerated R&D from the “Code Red” situation.

In this article, we will be discussing GOOG’s over sold status, thanks to the perceived lack of profitable growth trend for the Google Cloud segment, compared to its direct peers as the demand for Generative AI booms.

We believe that the company’s other segment has outperformed expectations, well balancing the Google Cloud’s mixed near-term prospects. We shall discuss further.

Google Remains Highly Profitable While Continuously Generating Robust Growth

GOOG 5D Stock Price

GOOG has now drastically plunged after the recent Q3 earnings call, with the stock also losing -11.9% of its value, or the equivalent of -$210B in Market Capitalization over the past few days.

We believe that the selloff has been overly done indeed, since the giant has reported an excellent Q3 earnings release, with FQ3’23 revenues of $76.79B (+2.9% QoQ/+11% YoY) and GAAP EPS of $1.55 (+7.6% QoQ/+46.2% YoY).

GOOG Revenues By Segment

Most importantly, the recovering advertising market has directly contributed to GOOG’s excellent advertising revenues of $59.64B (+2.5% QoQ/+9.4% YoY), thanks to the Google Search & Others.

While the default search agreement has costed the company a handsome sum of $26.3B, we believe that it is somewhat justifiable considering the returns thus far, with the segment’s annualized revenues of $176.08B (+3.2% QoQ/+11.3% YoY) continuing to generate robust growth.

While the WGA strike has ended, investors must also note that the SAG-AFTRA strike is still ongoing, with YouTube Ads likely to sustain the excellent FQ3’23 revenues of $7.95B (+3.7% QoQ/+12.4% YoY) over the next few quarters.

While Mr. Market has a bone to pick with Google Cloud’s growth rate, triggering the drastic correction in GOOG’s stock prices, we believe that the FQ3’23 revenues of $8.41B (+4.7% QoQ/+22.5% YoY) has been impressive indeed.

This is on top of the expanding remaining performance obligations, mostly attributed to Google Cloud at $64.9B (+7% QoQ/+23.8% YoY).

These numbers further solidify our conclusion that Mr. Market has been oddly too critical about GOOG’s Cloud prospects, especially when compared to Amazon’s (AMZN) FQ3’23 AWS revenues of $23.05B (+4.1% QoQ/+12.2% YoY) and backlog of $133B (+0.6% QoQ/+27.5% YoY).

Microsoft’s (MSFT) Azure similarly reported underwhelming Intelligent Cloud/Azure revenues of $24.25B (+1% QoQ/+19.3% YoY) and backlog of $19.47B (-9.6% QoQ/+12.6% YoY) in the latest quarter.

Thanks to the Fed’s sustained rate hike thus far, GOOG has also opted to make great use of its immense war chest of $119.93B (+1.3% QoQ/+3.1% YoY), with $89.23B used for short-term investments.

This strategy has generated the company a robust annualized net interest income of $3.8B by the latest quarter (+11.8% QoQ/+84.8% YoY).

It further contributes to GOOG’s growing Free Cash Flow generation of $22.6B (+3.8% QoQ/+40.6% YoY) and margins of 29.5% (+0.3 points QoQ/+6.2 YoY). This is compared to its FY2019 levels of 19.1% (+2.4 points YoY).

Deceleration In Google Cloud’s Growth

With these results, we believe that Mr. Market has overreacted over the deceleration in the Google Cloud growth indeed, since it is natural to experience a normalization after the pulled forward hyper-pandemic growth.

While its cloud segment’s profit margin has temporarily declined to 3.1% (-1.7 points QoQ/+9.5 YoY), compared to MSFT’s 48.4% (+4.6 points QoQ/+4.3 YoY) and AMZN’s 30.2% (+6 points QoQ/+3.9 YoY), GOOG’s overall profitability makes us willing to wait a little longer.

So, Is GOOG Stock A Buy, Sell, Or Hold?

GOOG Valuations

For now, perhaps the pullback may be attributed to GOOG’s rich FWD P/E valuations of 21.49x, with the deceleration triggering fears of a stalling growth engine, as demonstrated by the moderation from its 1Y P/E mean of 23.69x and 5Y mean of 25.97x.

Consensus Forward Estimates

However, we believe that the pessimism is unwarranted, based on the consensus optimistic forward estimates, with GOOG expected to generate an impressive top and bottom line growth at a CAGR of +10.1% and +19.5% through FY2025.

This is compared to its normalized levels of +21% and +17.7% between FY2016 and FY2022, respectively.

Based on the consensus FY2025 adj EPS estimates of $7.78 and the GOOG stock’s FWD P/E valuations of 21.49x, we believe that there is still a great upside potential of +35.4% to our long-term price target of $167.19, thanks to the recent pullback.

As a result of the attractive risk/reward ratio, we are rating the stock as a Buy.

There Are Risks To The GOOG Investment Thesis

GOOG 2Y Stock Price

Naturally, there are risks at adding here, since the pullback observed in the GOOG stock has yet to conclude, with it likely to retest its next support levels of $115s, implying a downside of -6.8% from current levels.

In addition, if the deceleration observed in Google Cloud’s growth continues over the next few quarters, we may see the stock’s valuations further discounted.

Global Venture Dollar Volume Through Q3 2023

While Sundar Pichai has boasted of its Cloud contract wins with over 50% of the “Generative AI startups,” investors must also note the moderating global venture capitalist funding of $73B (+7% QoQ/-15% YoY) by Q3’23, compared to the Q4’21 peak levels of $188.4B.

With many of these startups likely yet to generate sustainable profitability, it is uncertain if the consensus forward estimates may materialize, especially given the uncertain macroeconomic environment.

In addition, MSFT’s first mover advantage in the AI race is undisputed, with the company already launching multiple features based on OpenAI’s GPT-4 LLM, most notably Microsoft 365 Copilot.

This strategically leverages on the latter’s close partnership with multiple global enterprises and existing business offerings, further amplifying its growth momentum as the consumer/enterprise demand for Generative AI services remains robust.

It is unsurprising that Mr. Market has been disappointed with GOOG’s slower roll out, with Gemini (touted as the direct competitor to OpenAI’s GPT-4) only widely available from 2024 onwards, instead of the original timeline of Q4 ’23, with MSFT likely to gain market share in the AI race in the intermediate term.

While there has been progress thus far, with company giving “a small group of companies access to an early version,” it remains to be seen when and if Gemini is able to catch up to OpenAI’s GPT-4 lead.

Therefore, while we may rate the GOOG stock as a Buy, investors may want to monitor its movement for the next few days before adding according to their risk tolerance and dollar cost averages.

As a result of the potential headwinds, the stock may also trade sideways at these levels until the management is able to generate a profitable growth trend for its Cloud segment. This is an understandable concern given the generative AI boom.

This means that the Alphabet stock is only suitable for those with longer investing trajectory, since GOOG’s its reversal may take longer than a few quarters. Patience may be prudent for now.