Google Stock: The Market Is Wrong (NASDAQ:GOOG) – Looking for Alpha | Region & Cash

Alena Kravchenko

Despite the lack of analyst estimates for the second quarter, Alphabet Inc. (NASDAQ: GOOD, NASDAQ:GOOGL) (“Google”) advertising business held up well in Q2’22, not experiencing a Snap Inc. (SNAP)-like breakout that some investors feared ahead of earnings. While Slightly missing predictions, Google’s performance wasn’t all that bad: With reasonable strength in its search and cloud businesses, Google has once again proven it can generate plenty of free cash flow for the company and its shareholders!

Google’s search/advertising business continues to grow

The market is still impacted by Snap’s disastrous earnings report from last week. Snap saw its share price plummet 39% after it released its second-quarter earnings report, which indicated a worse-than-expected decline in the digital advertising market as well as growing competitive pressures from rival companies like TikTok.

However, Google presented much better Q2’22 results than Snap. The internet search giant posted earnings per share of $1.21 on sales of $69.69 billion, but slightly missed guidance for both numbers.

Google Q2'22 result

I’m looking for Alpha – Google Q2’22 earnings

The EPS and revenue shortfalls were relatively small and shouldn’t affect how investors view Google’s strong core businesses, particularly Google Search.

Google’s revenue for the second quarter of 2022 was $69.69 billion, up 13% year over year, driven primarily by two businesses: Google Search and Google Cloud. Google search, Google’s top business in terms of revenue and earnings contribution, had revenue of $40.69 billion in the second quarter, up 14% year over year. Although Google’s Q2 ’22 revenue grew at the slowest rate in two years, its search business continued to perform well. Concerns about a slowdown in the digital advertising market left Google shares ahead of earnings, and the market may now see that Google will continue to expand its search/advertising business despite modest revenue growth.

Google’s cloud business, the fastest-growing segment within the tech company, saw revenue increase 36% year over year to a record $6.28 billion. Due to the accelerated adoption of cloud platforms by the company’s enterprise customers, Google’s cloud business now accounts for a 9% share of revenue, down from a 5% share three years ago. Google’s cloud business is booming, and investors can expect this segment to continue to generate the fastest growth rate within Google going forward. I estimate that Google Cloud will grow to a 14-15% revenue share by fiscal 2025, and it’s by far the most promising business for Google right now.

$million

Q2’21

Q2’22

Y/Y growth

Share of sales (Q2’22)

Google search and others

$35,845

$40,689

13.51%

58.39%

YouTube Ads

$7,002

$7,340

4.83%

10.53%

Google network

$7,597

$8,259

8.71%

11.85%

Google others

$6,623

$6,553

-1.06%

9.40%

Google cloud

$4,628

$6,276

35.61%

9.01%

Other bets

$192

$193

0.52%

0.28%

validation

($7)

$375

0.54%

total revenue

$61,880

$69,685

12.61%

100.00%

(Source: Author)

Ad revenue growth is slowing on YouTube

TikTok has emerged as the next hot social media platform and is hugely popular among younger users. TikTok’s growing popularity was partly to blame for Snap’s second-quarter monetization woes, and YouTube is also seeing a slowdown in ad revenue growth. YouTube ads generated just 5% year-over-year growth in Q2’22, largely due to growing competition from other short-video streaming platforms. Revenue from ad serving on the YouTube platform grew 14% in Q1 2022 and 84% in Q2 2022 due to a pandemic surge. The slowdown in YouTube ad revenue growth poses a challenge for Google, but it’s not a problem so significant that it would make it against owning Google stock.

Free cash flow

What I love about Google is the company’s massive free cash flow (“FCF”). In Q2 2022, Google generated $12.59 billion in free cash, which translates to an 18.1% FCF margin. Although Google’s FCF margin has declined quarter-on-quarter, the tremendous amount of free cash flow that Google’s companies are generating will continue to support large-scale share buybacks.

$million

Q2’21

Q3’21

Q4’21

Q1’22

Q2’22

revenues

$61,880

$65,118

$75,325

$68,011

$69,685

Cash generated from operations

$21,890

$25,539

$24,934

$25,106

$19,422

Less: Acquisition of real estate and equipment

($5,496)

($6,819)

($6,383)

($9,786)

($6,828)

Free cash flow

$16,394

$18,720

$18,551

$15,320

$12,594

Free Cash Flow Margin

26.5%

28.7%

24.6%

22.5%

18.1%

(Source: Author)

Alphabet is expected to post revenue of $334.15 billion in fiscal 2023. Applying a 20% FCF margin to that revenue basis gives free cash flow of $66.83 billion. Assuming a market value of $1.39 trillion, shares of Google have a P-FCF ratio of 21X. Considering that Google is the dominant force in the search market and FCF margins are very high, is Google is an exceptionally good deal for growth investors.

diagram
Data from YCharts

Risks with Google

Google delivered solid earnings in the second quarter despite an EPS miss, and fears of a slowdown in its advertising business are overdone. A bigger challenge for Google, and YouTube in particular, is the rise of TikTok as an alternative advertising platform that attracts a younger demographic. Because of this, YouTube could continue to see a slowdown in ad revenue growth going forward, which would also impact Google’s revenue prospects.

Final Thoughts

The market is wrong about Google and the company’s Q2 earnings chart proved it: the ad market is holding up and the search giant continued to generate plenty of free cash flow in Q2’22. Google’s search and cloud showed reasonable growth despite mounting economic headwinds. With Google’s free cash flow remaining strong and the valuation factor remaining cheap at 21X, Google stock continues to have a highly skewed risk profile to the upside!

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