Google’s (NASDAQ:GOOGL) (NASDAQ:GOOG) Q2 report was positively received by the market, as investors expected the digital ad leader to deliver a dismal performance after Snap’s (NYSE:SNAP) terrible results the previous week.
Furthermore, YouTube’s growth engine has suffered dramatically due to difficult comps and the continuous signaling impact of Apple’s (NASDAQ:AAPL) App Tracking Transparency (ATT) framework. When combined with Google Cloud’s unprofitability, the growth cadence of search advertising will be vital to maintaining its pace. Furthermore, Apple (NASDAQ:AAPL), Amazon (NASDAQ:AMZN), and TikTok (BDNCE) rapidly increased their market share in the digital ad sector. As a result, Google will face stronger competition, limiting its capacity to maintain its prior growth rates.
Regardless, we believe Google’s position in digital advertising is unrivalled and unlikely to be challenged in short to medium term. As a result, we continue to favour (NASDAQ:GOOGL) as a critical digital advertising exposure in investors’ portfolios. As a result, we maintain our Buy rating on GOOGL but caution investors to temper their expectations for future outperformance.
Search Remains Resilient Despite Weaker Macros
Google reported 12.6% revenue growth yearly, with 0.5% adjusted EBIT growth. Search advertising climbed 14% yearly, thanks to travel and retail, while YouTube’s growth slowed dramatically. As noted above, YouTube’s growth has slowed significantly to 4.8% yearly, validating a significant slowdown that began in Q2’21. As a result, we don’t believe YouTube has been “immune” to Apple’s ATT adjustments. It also appears to have been adversely harmed by growing macroeconomic conditions.
Google has yet to explain why its search and YouTube results are so dissimilar. Blaming harsh YoY comps for YouTube is a bogus herring, considering that CFO Ruth Porat mentioned that search was growing well despite the tough YoY comps later in the results call. The best reason remains that YouTube has more brand advertising, which falls during economic downturns. Furthermore, YouTube relies heavily on direct response advertising, which ATT has severely undermined.
Google Cloud Platform (GCP) growth has also slowed significantly, implying that macroeconomic headwinds may harm cloud investment in the near term. GCP’s unprofitability would impact the company’s overall profitability growth, worsened by YouTube’s slowdown and a generally poorer ad market. However, we are less concerned about its long-term growth prospects because we expect cloud spending to continue expanding, with GCP gaining market share.
Recovery For Google From FY23, But Don’t Expect Outperformance
Google has continued to invest, which will most certainly impact its EBIT growth cadence. However, we believe the company is taking advantage of its competitors’ reduced investment to solidify its leadership further and protect its market dominance. In a June report, eMarketer warned that Meta (NASDAQ:META) and Google would likely continue losing market share in the coming years.
For years, Google and Meta Platforms have held a strong combined share of the digital advertising business, but their grip is slipping. The fall for Google and Meta comes as TikTok, Amazon (NASDAQ:AMZN), Walmart (NYSE:WMT), and Apple (NASDAQ:AAPL) gain market share in digital advertising. Regardless, the consensus projections (extremely bullish) show that Google is expected to recover from its bottom in Q1’23, as shown above. As a result, given its reasonable valuation levels, we remain convinced that the market will not punish GOOGL any further.
Still, Don’t Expect Outsized Performance From GOOGL Moving Ahead
Since our last piece, Google has underperformed the Invesco QQQ ETF (QQQ). Nonetheless, its return remains close to that of the SPDR S&P 500 ETF (SPY), and GOOGL beat its Communications (XLC) counterparts in general. Compared to its tech (XLK) counterparts in general, GOOGL has fallen far behind, as we believe the market has de-rated the ad leaders, including META (NASDAQ:META).
GOOGL’s three-year annualized total return CAGR surpassed its five-year and ten-year averages. As a result, we feel the de-rating is appropriate because Google’s growth rates could not be sustained. Notably, Google’s future medium-term revenue and EPS CAGR based on revised consensus expectations through FY26 is unlikely to repeat its last 3Y, 5Y, or 10Y averages. As a result, we believe it is unreasonable to expect the digital ad leader to continue outperforming the market in the future, given the significantly decreasing growth pace.
Is GOOGL Stock A Buy, Sell, Or Hold?
We continue our Buy recommendation for GOOGL. However, we believe it is just a market-perform rating because its growth is anticipated to decline significantly over the next few years. However, we believe its competitive moat is strong and remains a solid core investment for digital advertising investors. Furthermore, its GCP flexibility and recovery from YouTube’s near-term difficulties should deliver additional upside surprises to our thesis.
Featured Image: Megapixl © Miluxian
