Alphabet's solid second quarter is clouded by U.S. regulatory pressure

Published Tue, Jul 25 20237:49 PM EDTUpdated Wed, Jul 26 202311:42 AM EDT

Alphabet (GOOGL) reported better-than-anticipated quarterly results after the closing bell Tuesday, sending shares soaring. But we remain highly cautious about the stock's long-term upside given ongoing regulatory challenges in the U.S. Total revenue for the three months ended June 30 climbed by around 7%, or 9% on a constant-currency basis, to $74.6 billion, outpacing analysts' estimates of $72.82 billion, according to Refinitiv. Adjusted earnings-per-share (EPS) increased 19% from a year ago, to $1.44, exceeding Wall Street's consensus estimate of $1.34 per share, Refinitiv data showed. Bottom line This was a very strong second quarter from Alphabet. Not only did we get a top-and-bottom-line beat, but also operating-margin expansion. It was also the first quarter in a while during which revenue growth outpaced that of expenses. In addition to operating income exceeding expectations in every area of the business, capital expenditures were lower than expected, while cash flows significantly beat Wall Street's expectations. Meanwhile, while management reaffirmed the company's commitment to "durably reengineering" its cost base, investments in technical infrastructure will pick up in the back half of 2023 and into 2024 primarily to continue building out its artificial intelligence capabilities. Alphabet is clearly working diligently to pull back on less-critical investments, while focusing on the more important ones that stand to pay off near term. That strategy should support both revenue growth and profit margins going forward. The commentary on investment growth around technical infrastructure — which includes the purchase of advanced NVIDIA GPUs — is certainly welcome ahead of Club name Nvidia 's (NVDA) earnings release in August. This is because it suggests the demand momentum the semiconductor firm has seen for its AI chips is sustainable, at least into the third quarter. Despite these positive developments — including an acceleration in revenue growth at its internet search business — the overhang from the U.S. Department of Justice's ongoing antitrust lawsuit against Alphabet keeps our excitement tempered. As Jim Cramer indicated Tuesday , the 6% pop in afterhours trading increases the likelihood we will look to sell some shares in order to reduce our position in the technology giant and protect the Club's broader portfolio. As much as we like this business and its future prospects — should the company prevail in the DOJ case and remain fully intact — we struggle to justify allocating additional capital to the name at current levels knowing that the regulatory headwind threatens at least some of the company's advertising technology ecosystem. Therefore, though we are bumping up our price target to $140 a share, up from $125, we are maintaining a 2 rating on the stock. We think shares can edge higher over time thanks to management finally getting cost growth below revenue growth. The impressive cash-flow generation should also continue to support share-repurchase activity going forward. Sales by segment Sales strength for the quarter was broad based, with only a marginal miss at Google Networks. More importantly, strong cost control resulted in operating income outpacing expectations across all operating units, while contributing to better-than-expected cash flows. In Google Search, the growth was led by the retail vertical. At YouTube, management called out stabilization of spending by advertisers. The team also noted that monetization of its YouTube short-video and YouTube in-the-living-room offerings is improving. Other revenue growth was driven by subscription growth in YouTube Music Premium and YouTube TV, along with growth in hardware revenues driven by the launch of the Pixel 7A phone during the quarter. Regarding Google Cloud, management on Tuesday emphasized strength "across geographies, industries, and products," but added that customer-optimization efforts are ongoing. As a result, consumption growth continues to moderate. Still, management said the company will "continue to invest aggressively while remaining focused on profitable growth." Capital returns Alphabet returned $14.97 billion to investors via share repurchases in the second quarter, though the company paid out $5.77 billion in stock-based compensation. It exited the quarter with $118.3 billion in cash, cash equivalents and marketable securities on its balance sheet. The company also announced that CFO Ruth Porat will transition to president and chief investment officer in September. Until then, she will plan for the year ahead as the search for a successor gets underway. (Jim Cramer's Charitable Trust is long GOOGL, NVDA. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED.

Google CEO Sundar Pichai speaks at a panel at the CEO Summit of the Americas hosted by the U.S. Chamber of Commerce in Los Angeles on June 9, 2022.

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