When they look at the stock price and news coverage this morning, the management of and investors in Google’s parent company Alphabet (GOOG: GOOGL) must feel like they are in the middle of some giant riddle, something along the lines of “when is an earnings beat not a beat?” or “when is growth not growth?”
Unfortunately for them, the answer to both those questions seems to be, “when it’s Google."
The numbers were mixed in relation to expectations. EPS of $11.90 per share was well above the consensus estimate of $10.61, but revenue of $36.34 billion fell short of the expected $37.33 billion. Understandably, it was the second number that caused the stock to lose ground immediately following the release, but, put simply, the adjustment looks way overdone.
That revenue number represents a 17% increase year over year, a significant drop from the 28% achieved a year ago, and that had analysts immediately going on the attack. As RBC’s Mark Mahaney put it, they were left asking “Hey Google, what happened to revenue growth?”
A big selloff on slower than expected growth would make perfect sense if Alphabet’s stock were priced like other FAANG stocks such as Amazon (AMZN) and Netflix (NFLX), but it isn’t. Those two names trade at around 80- and 170-times trailing earnings respectively. GOOG, on the other hand, went into yesterday’s release with a trailing P/E of just under 30.
That is higher than the average P/E of around 22 for the S&P 500 and, more relevantly, also higher than the 23.67 average multiple of Nasdaq-100 stocks, but is it really high enough to justify an 8% drop in the stock on revenue growth of seventeen percent?
Given that Amazon also showed year on year revenue growth of 17% in its last earnings report and Netflix grew by 22%, it is not a stretch to say that it isn’t, so something else must be going on here.
First and foremost, as I have said many times in the past, a stock’s reaction to earnings or news of any kind is often more about market positioning and sentiment going into a release than the substance of the release itself. This is a case in point. GOOG is up 32.7% since the low on Christmas Eve and has gained 7.9% over the last three weeks in the runup to earnings.
Compare that to the S&P 500, which has delivered a 25.2% gain since December 24 and a roughly 2% rise since early April and it is clear that expectations for Alphabet were high.
The problem here is not just that revenue growth missed the “official,” published estimates, it is also that traders and investors got carried away in anticipating a beat rather than a miss of those guesses. That is not Alphabet’s fault, but the other reason for the outsized drop could be said to be so.
Alphabet doesn’t play the game. They refuse to issue any guidance for future earnings and revenue and seem intent on revealing as little as possible in each earnings report: a common theme among the initial reactions of analysts that cover the stock was an appeal for more “transparency” from the company. That frustrates analysts and traders alike, who are used to being told what to expect, and that in turn frequently leads to exaggerated responses to deviations from those expectations, positive or negative.
It is quite possible that the negativity will continue for a day or two as others revisit their forecasts in the light of these earnings, so waiting before buying would be a prudent move. Recent history, however, suggests that buying when the dust settles would be a good trade.
Three months ago, when Alphabet last reported, there was a similar reaction. Lower cost-per-click numbers slowed growth then too, at least relative to expectations, and then too, the stock dropped after a strong run up into the release. At that time, I wrote that investors should not be concerned, and GOOG rose over 20% from then to yesterday’s close.
The recovery this time may not be as spectacular, but once again it seems that Google is a victim of its own past success and is being punished for failing to live up to the unreasonable enthusiasm of a market deprived of guidance. That is understandable, but probably not sustainable, and once again, a bounce back can be expected.