Google recently reported second-quarter numbers that were really good. Revenues topped expectations, and revenue growth remained above the all-important 20% level. Earnings absolutely smashed expectations, led by slower-than-usual Traffic Acquisition Cost (TAC) growth and less-than-expected margin compression.
Net result? GOOG stock rose by a few percentage points to fresh all-time highs.
This rally in GOOG stock has legs. The Q2 report was critical in that it showed, in numbers, that the company's biggest go-forward headwind, out-sized TAC growth, is moving into the rear-view mirror. With that headwind now largely behind it, Google can get back on a margin-expansion trajectory. On that trajectory, GOOG stock could soar above $1,350 by the end of the year.
Here's a deeper look.
Google's Q2 Numbers Were Really Good
Google's second quarter numbers were nothing short of spectacular.
The revenue side isn't all that surprising. Google search continues to dominate the internet. YouTube is getting a big boost thanks to growing demand for digital video ads. Google Cloud is gaining market share. Google's hardware business, which is comprised of Google Home and Pixel, is also making inroads. Google Play is a rapidly growing software service.
All together, revenue growth was yet again above 20%. Google Sites revenue, which is made up of Search and YouTube, was up 26%. Other Bets revenue (Cloud, Hardware, and Play) was up 37%.
None of that is terribly surprising. This is, has been, and will remain a 20%-plus revenue growth company thanks to broad exposure to all things internet.
But the surprising part came on the margin line. Operating margins were 24% in the quarter. That is down just 2 percentage points from 26% in the year-ago quarter. Last quarter, operating margins fell 5 percentage points year-over-year.
In other words, margin compression, which has been the single biggest thing holding back GOOG stock, is moderating. That is because TAC growth, the single biggest thing holding back margins, is moderating. TAC is still trending higher thanks to the mobile shift (mobile has higher TAC than desktop), but the rate of growth is moderating as scale kicks in.
Because of this moderating TAC growth, earnings smashed expectations in the quarter. That is mostly why GOOG stock rallied after the print.
Google Stock Could Hit $1,350 by the End of the Year
If TAC growth continues to moderate into the foreseeable future, as management expects, then this rally could be just the beginning for GOOG stock.
As stated earlier, TAC growth has really been the only thing holding back GOOG stock. We all know how great this company is on the top-line with consistent 20%-plus revenue growth. And this is before big growth drivers like Waymo (self-driving) and Wing (self-flying) have shown up on the income statement.
Thus, this is easily a 20% revenue growth company over the next several years, powered by moderating digital advertising and cloud growth and accelerating new revenue growth from Waymo and other ventures.
TAC growth was 26% in Q2, versus 30%-plus in the past two quarters. If TAC growth can come down to 20% or less, then Google could actually begin to see healthy margin expansion again. I think that is likely and, because of this, I believe that Google's operating margins can trend towards 26-27% over the next five years.
Under those assumptions, I believe Google can net around $90 in earnings per share in five years. A growth-average 20 forward multiple on that implies a four-year forward price target of $1,800. Discounted back by 10% per year, that equates to a year-end price target for GOOG stock of just over $1,350.
Bottom Line on GOOG Stock
The long-term growth narrative supporting GOOG stock just improved dramatically thanks to moderating TAC growth in Q2. This paves the path for margins to bounce back over the next five years.
With revenues and margins now set to head higher in a multi-year window, this is a stock which should be able to perform exceptionally well over the next several years.
As of this writing, Luke Lango was long GOOG.
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