Can continued cloud growth send the Alphabet share price skywards?

Going into earnings season, the Alphabet [GOOGL] share price has outshone the other FAANG stocks. 

The Alphabet share price is up 51.8% year-to-date, from $1,752.64 to $2,660.30 at the close on 23 July. This is compared to gains of 12.3% and 30.8% for Amazon [AMZN] and Microsoft [MSFT], respectively. Apple [APPL] and Netflix [NFLX] are both down since the start of January. 

Despite market concerns that big tech stocks are overvalued amid fears of interest rate rises, the Alphabet share price has far outpaced the broader Nasdaq 100 Technology Sector’s return of 16% year to date.

  

The Alphabet share price is up 675.4% in the 52 weeks to 23 July and is currently trading at a new all-time high. But it begs the question: is the Alphabet share price too high going into its second quarter of 2021 earnings, due on 27 July, or could it push past the $3,000 mark?

 

Can the Alphabet share price rise post-earnings?

In the first quarter of 2021, Alphabet brought in $55.31bn in revenue versus $51.70bn that analysts polled by Refinitv had expected, and up 34% from the $41.16bn reported in the first quarter of 2020. This made it the best-performing quarter for year-over-year growth since the fourth quarter of 2013. 

Earnings per share were $26.29, easily surpassing the analyst expectation of $15.82 per share. 

The comfortable and big beats had the company’s advertising segment to thank for the most part. Sales were up 32% from $33.76bn to $44.68bn. Meanwhile, Google Cloud revenue rose by 46% to $4.05bn, reportedly in line with what Wall Street had been expecting. Operating losses for Google Cloud were reduced from $1.73bn in the first quarter of 2020 and $1.24bn in the previous quarter, to $974m. 

  

The company didn’t offer up any forward guidance, but analysts polled by Zacks Equity Research are expecting revenue to be between $41.13bn and $48.09bn, with the middle of the range representing a 45.8% increase year-over-year. Earnings per share are expected to be between $17.08 and $22.99, with a consensus of $19.89, which would be a huge 96.4% increase from second quarter of 2020. 

 

Watching the cloud

When it comes to second-quarter earnings, a lot of investors’ eyes are likely to be on Google Cloud. The assumption is that growth will continue to be strong — revenue has more than doubled from $5.8bn in 2018 to $13.06bn in 2020. Though Google Cloud lost $5.61bn in the last fiscal year, losses continue to narrow quarter-over-quarter. 

On the first quarter of the 2021 earnings call, Ruth Porat, CFO of Alphabet, said the company would continue to “invest aggressively” in cloud products in its bid to compete with Amazon Web Services and Microsoft Azure. Sunar Pichai (pictured), CEO of Alphabet, echoed this during the call, adding that the company would continue to “unlock the value of the Google ecosystem” through partnerships.

With this in mind, investors will be watching to see if Alphabet is able to capture more of the cloud market this year. In the first quarter of 2021, it had just a 7% share compared with a 32% share for Amazon and 19% share for Microsoft.

The caveat is that these market share splits haven’t moved much over the last few years, give or take a percentage point here or there. Writing for Forbes back in December, Beth Kindig, a technology analyst and CEO of I/O Fund, suggested “the window of opportunity” for aggressive investment would have ideally been 2017 and 2018, “to stave off Azure’s high-growth years”.

“Perhaps there will be a catalyst in the future for Google Cloud to take more share, but the strategy is not evident at this time,” added Kindig. 

“Perhaps there will be a catalyst in the future for Google Cloud to take more share, but the strategy is not evident at this time” - Beth Kindig, technology analyst & CEO of I/O Fund

 

Mark Mahaney, an analyst at Evercore ISI, has reservations about whether Alphabet can transform the cloud market from a “two-horse, one-pony race into a three-horse race”, according to a note to clients seen by Barron’s. Nonetheless, he believes the Alphabet share price and the stock’s investment thesis doesn’t have to depend on the cloud, citing a strong outlook for search and monetisation opportunities in Google Maps. 

Mahaney has a target of $2,825 for the Alphabet share price and assigned the stock an outperform rating. 

Alphabet’s cloud business could yet prove to be its biggest weapon, especially as the company looks to reduce its reliance on advertising. Until then, communication-focused funds give exposure to the company.

The Communication Services Select Sector SPDR Fund [XLC] has a daily total return of 21.09% year-to-date as of 23 July and the iShares Global Comm Services ETF [IXP] has returned 16.64%. Both ETFs have Alphabet as their second-biggest holding.