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Alphabet’s (NASDAQ:GOOG) (NASDAQ:GOOGL) strong earnings sheet for the first fiscal quarter resulted in a 12% upsurge in Google’s share price after-hours and the technology company seems set for a new up-leg in the near future as well. Google reported much better than expected results due to a strong, continual recovery in the digital advertising market as well as consistent results in Cloud. Google especially convinced with strong free cash flow margins which led to another surprise: the tech company announced the introduction of a cash dividend which is set to boost investors’ total returns going forward. The dividend initiation is a game-changer for Google and I believe the risk profile remains skewed to the upside!
Previous rating
I rated shares of Google a strong buy — Why I Aggressively Doubled Down On Google — after shares sold off undeservedly after Q4’23 results. Google’s main digital marketing platforms, Google Search and YouTube, generated strong top line growth in Q4’23 and this momentum continued in the first-quarter as well. Google also saw a revenue acceleration compared to the previous quarter and investors can expect higher capital returns going forward.
Google beats Q1’24 estimates easily
It was a very strong first-quarter for Google which resulted in a sizable revenue and earnings beat. Google reported $1.89 per-share in GAAP earnings which beat the consensus expectation by a massive $0.38 per-share. Revenues also came in $1.84B higher than the consensus estimate.
Revenue acceleration, FCF margin expansion, dividend initiation
Google’s core businesses digital advertising and Cloud both delivered strong growth in the first-quarter. Google generated $80.5B in revenues in Q1’24, showing 15% year over year growth as well as a 2 PP acceleration of its top line compared to the fourth-quarter. Both Search and Cloud did extremely well: Search generated 14% Y/Y growth driven by a strong state of the advertising market. Similarly, Meta Platforms (META) just released very strong (but less well-regarded) Q1’24 results, also due to strength in digital advertising. YouTube is also seeing strong ad momentum, driven by video ads, with the segment generating 20% more revenues than in the year-earlier period.
Google’s Cloud segment generated 28% year over year growth compared against a 26% Y/Y growth rate in Q4’23. Therefore, the two most important revenue drivers for Google, Search and Cloud, actually saw sequentially growing strength… which also resulted in an expansion of the company’s free cash flow margins.
Google
The key to understanding Google’s capital return potential is the company’s enormous free cash flow: Google generated $16.8B in free cash flow in the first-quarter, showing a Q/Q increase of 113%. Google was also able to more than double its free cash flow margins quarter over quarter due to strength in Search/video ads and Cloud, resulting in an FCF margin of 20.9%.
|
$millions |
Q1’23 |
Q2’23 |
Q3’23 |
Q4’23 |
Q1’24 |
Y/Y Growth |
|
Revenues |
$69,787 |
$74,604 |
$76,693 |
$86,310 |
$80,539 |
15.4% |
|
Net cash provided by operating activities |
$23,509 |
$28,666 |
$30,656 |
$18,915 |
$28,848 |
22.7% |
|
Less: purchases of property and equipment |
($6,289) |
($6,888) |
($8,055) |
($11,019) |
($12,012) |
91.0% |
|
Free cash flow |
$17,220 |
$21,778 |
$22,601 |
$7,896 |
$16,836 |
-2.2% |
|
Free cash flow margin |
24.7% |
29.2% |
29.5% |
9.1% |
20.9% |
-15.3% |
(Source: Author)
Google’s free cash flow strength has now resulted in management for the first time ever announcing a $0.20 cash dividend, to be paid to shareholders on June 17, 2024, which is set to boost investors’ shareholder returns going forward. Google also announced a $70.0B stock buyback again and it seems that Google wants to follow into the footsteps of Meta Platforms which announced in the previous quarter that it was becoming a dividend stock as well.
In the first-quarter, Google repurchased $15.7B of its own shares which calculates to an impressive free cash flow return percentage of 93%. The combination of a new aggressive stock buyback (which represents 3.6% of Google’s market cap) and now the introduction of a dividend makes Google stock obviously more attractive to a wider circle of buyers now… which may boost demand for demand for Google’s shares and push them into a new up-leg.
Google’s valuation, updated fair value
From a valuation point of view, Google is one of the cheaper large-cap U.S. tech companies. Google is currently valued at a P/E ratio of 20X and is expected to grow its EPS at double-digits annually in the next several years. In my last work on Google I calculated a fair value range of $164-171 per-share for Google, but given the acceleration of the company’s top line growth Q/Q, massive free cash flow (margins) and improved capital return potential, I don’t see how Google could not trade at a 25X P/E ratio. This would make shares only slightly more expensive than Apple’s (which have a 24X P/E ratio), but Google is more diversified and does not depend on the volatile consumer electronics market. Applying a fair value P/E ratio of 25X (FY 2025 EPS: $7.83) leads to a fair value of $196 per-share, implying ~25% upside revaluation potential based off of Google’s closing price of $158 on Thursday.
I continue to see massive revaluation potential for Google in FY 2024 driven by 4 catalysts:
- Strong growth in the company’s core business digital advertising (including both Search and YouTube) and Cloud
- The cash dividend initiation may attract a new group of buyers into the shares
- The new $70.0B stock buyback will allow Google to buy back approximately 4% of its outstanding shares
- EPS estimates are likely to reset to the upside after Google’s massive Q1’24 beat.
Risks with Google
The biggest risk for Google, as I see it, relates to the tech company’s AI products. AI development is expensive and whoever has the most effective artificial intelligence product in Search, as an example, is likely going to dominate the market. This, in a certain way, equalizes the playing field and opens up Search to a wider field of competitors, including small AI development companies. If Google misses the boat on its AI development, the core Search business could become less valuable going forward.
Closing thoughts
Google is at the cusp of another upside breakout given the positive market reaction to the company’s first-quarter earnings sheet on Thursday. The continual recovery in the digital advertising business, signified by Google’s double-digit top line growth in Search and YouTube ads, as well as Cloud momentum are key to my favorable outlook on Google’s shares. Importantly, Google announced a dividend for the first time ever which is a game-changer as it boosts the company’s cash returns to shareholders. From a valuation point of view, I believe Google has both a number of catalysts speaking in its favor and shares remain relatively cheap, especially when compared against other large-cap U.S. tech companies!
