After the closing bell on Monday, Alphabet (GOOGL - Get Report) delivered third quarter results that can be considered "more of the same." But when it comes to the Mountain View-based tech giant's financial performance, status quo is great news for Alphabet investors.
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Interestingly, the market seemed less than impressed by the company's large earnings miss: $10.12 per share reported against consensus expectations of $12.46 per share. The stock dipped in after-hours trading, settling about 2% lower at the end of the earnings conference call, and was down 2.3% to $1,259.18 on Tuesday afternoon. However, Alphabet's bottom-line number was impacted by unusual items that ended up masking the strong performance of the underlying business.
Revenues increased 20% year-over-year, a rate that would have been two percentage points higher, if not for foreign exchange headwinds. Mobile search, YouTube and cloud continued to lead the charge, while even the more mature desktop search and hardware businesses were reported to have performed well in the third quarter. Advertising, representing nearly 85% of total company sales, grew at a slightly faster pace than it had in the previous quarter.
Unsurprisingly, Alphabet's enviable margins continued to shrink, but not for reasons that should worry investors too much. Cost of revenues was rich due to investments in data center and content, while traffic acquisition expenses remained under control.
Research and development costs saw a spike caused by the hiring of engineers and product innovation personnel. But worth noting, Alphabet has traditionally been generous with its infrastructure and human resource spending in order to facilitate longer-term growth, and the company was always upfront with shareholders regarding its investment strategy.
Total company operating margin, which looked soft at first glance, would have been approximately 130 basis points better if not for a $554 million charge associated with a legal settlement in France. In addition, Alphabet's earnings took a hit from loss in equity investments to the tune of $1.5 billion, the bulk of which was likely associated with Uber (UBER) .
Assuming no tax impact for simplicity, I estimate that these two items, largely unrelated to Alphabet's core operations, caused a negative impact of nearly $3 to the company's EPS -- more than enough to turn a third quarter earnings miss into a beat. Therefore, once unusual items are taken into account, Alphabet's performance looked much more robust than it seemed at first glance.
Investment Thesis Remains Intact
Alphabet shares have finally regained their all-time highs, after falling more than 20% to its 2019 low in the second quarter. Therefore, the stock's current forward earnings multiple of 23 times, on the rise for the past several months, may not look like a bargain to some value investors.
But given the company's strong execution, the hefty price tag seems justified. Growth, not only in the legacy advertising business but also in cloud, AI and self-driving technology, appears to have a long runway ahead. It doesn't hurt that Alphabet is currently sitting on a cash pile of over $120 billion with little debt to offset it, providing the tech giant with enough dry powder to take advantage of opportunities.
In my view, shares of Alphabet still look like a compelling GARP play (growth at a reasonable price) at current levels, more so if the stock experiences weakness and pulls back following the company's third quarter report.
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