Why Is Google Lower After Earnings Beat, And Should Investors Worry?

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Here we go again! Another high-profile company has reported earnings that beat expectations, in their case on both the top and bottom lines, and the stock is trading lower. This time, this phenomenon is affecting Google parent Alphabet (GOOG: GOOGL).

Often that is a result of lowered guidance for the coming quarter or year, but Alphabet doesn’t offer any guidance, so that is not the case here. The main reasons being quoted are a lower than anticipated “cost per click,” a measure of the advertising rates being charged, and increased spending. Neither, however, holds up as a reason for regular investors to sell the stock.

First, let’s look at the numbers. EPS for Q4 came in at $12.77, a significant beat of the FactSet consensus estimate of $10.86, while revenues also beat Wall Street predictions, coming in at $39.3 billion, an impressive 22 percent year-on-year gain.

That revenue number gives an indication of why the argument about lower cost per click is not a reason to sell GOOG.

Companies strive to maximize profit. Sometimes that is best achieved by high prices that drive high margins, but sometimes the market doesn’t allow that. When that is true, a company must have the flexibility to adjust to a lower margin, higher volume model. That is what Alphabet did last quarter, and the beat on the bottom line shows that they did so successfully.

If you believe that lower cost per click is a reason to sell despite higher revenue and profit than expected, then you believe a company should essentially be punished for being flexible; a patently ridiculous position to take.

Punishing the stock of a corporation for increased spending is, I guess, somewhat more logical, but even that makes little sense in context. Google is and always has been a growth story, and continued growth costs money. They find themselves way behind Amazon (AMZN) and Microsoft (MSFT) in the cloud business, an area that still offers the prospect of explosive long-term growth. It is their determination to catch up in that field that is sparking much of the capital expenditure, and that should be a good thing for long-term investors.

On the earnings call that followed the release, CFO Ruth Porat said that they expected the rate of growth of capex spending to slow significantly in 2019 and subsequent years, but the market evidently wasn’t satisfied. This is not the first time that Google has upset traders by higher costs than they wanted, but those instances have only served to highlight how those short-term concerns shouldn’t guide investors with a longer-term view. The proof is in the chart below.

Those “too high” investments have led to the stock gaining well over five-hundred percent in the last ten years. Until they prove otherwise, I for one still trust Google’s judgement.

So, neither of the most publicized reasons for GOOG trading lower after a beat makes sense. There are, however, a couple of other things that may be having an impact. The first is something I often talk about, market positioning. GOOG has been moving up with the market since Christmas and jumped a couple of percentage points yesterday in anticipation of earnings. That no doubt resulted in some profit taking on the beat that may go some way towards explaining the drop.

Then there are also the longer-term, broader worries that surround Alphabet right now. Privacy concerns are high given a couple of high-profile breaches and incidents and the company has faced several complaints related to workplace culture. You may see either or both of those as a moral reason not to own the stock, but after this earnings release, neither can be seen as a financial reason. Google seems to have reacted to both situations, and profits were high and rising, even as those things played out.

There is one other thing that could explain the drop in Google stock. As this Therese Poletti piece at MarketWatch points out, most of the earnings beat can be attributed to one thing: an unspecified investment gain of $1.3 billion. Without that the EPS would have been around $10.91, a lot closer to the estimates. The argument would be that that is a one-off and has nothing to do with future prospects, which kind of makes sense. But, selling GOOG on that basis still comes down to punishing the company for getting something right.

All of the above constitute reasons for fast money to leave Alphabet, and therefore for a short-term downward adjustment in price. None, however, say anything about the company’s ability to fulfill its most basic function and make money over time. The news yesterday on that front was positive once again, so long-term investors should be encouraged by that, rather than be worried about the reaction.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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