ALPHABET CRUSHED EARNINGS (GOOG STOCK). TIME TO BE CAUTIOUS?

[00:00:00]Alphabet shareholders are responding to the second-quarter earnings update with a bit of caution. The shares are down around 3 to 4% following the earnings update, and truthfully, it was an amazing quarter in the sense that they reported over $100 billion in earnings while at the same time saying that they burned around $6 billion in cash. I mean, that is truly incredible. In this video, I'm going to explore what's going on with Alphabet or Google's business, why the share price has sold off slightly in the after hours, along with my own caution on the stock from here, thinking about the valuation in the years ahead, and what it would take to deliver a potential teens return from here in the years ahead. So, to sort of walk through that framework, particularly focusing on that cloud segment, which everyone is so pumped about saying that just this tremendous AI-driven demand and growth.

[00:00:58]As always, my name is Daniel. You're watching Unrivaled Investing. So, let's dive deeper into understanding what is going on with Alphabet because they had this monster earnings, cash burn, what's going on? And so, when you look at their results, you can see revenue accelerating, which investors generally love to see, going from 14% growth last year to around Profit margins continuing to expand, both of these chiefly driven by their cloud segment. However, what really jumped out was their other income. You can see last year was around $3 billion.

[00:01:31]This quarter is around $100 billion.

[00:01:33]That's almost all from their investment in SpaceX. At least that's my impression, owning SpaceX stock, and then all of a sudden, a sizable mark-to-market adjustment. So, that's what you're seeing here. So, I I would focus instead on their core profitability around $40 billion per quarter.

[00:01:51]Now, digging into their sales results, you can see their search business, the Google search properties growing around 17%. YouTube ads growing around 13%. The other sites declining slightly. This is a trend that we've seen now for multiple quarters. Looking at Google subscriptions, their platform, the devices also growing solidly at 15%. So, overall Google services in total very solid around 15% growth. But, really what takes the cake, what gets everyone super pumped is seeing Google Cloud segment continue to accelerate. Last quarter is around 60% growth. Now, it's around 82% growth in the quarter. That's partly expected based on the backlog that management talked about last quarter that suggested they would be around $100 billion annualized. That was, you know, extrapolating based on their backlog conversation. So, that's largely what you're seeing here now with around $25 billion in sales in their cloud segment. And that that acceleration in cloud is part of the reason why a big part of the reason why their total revenues is accelerating to around 24%.

[00:03:01]Really impressive. And then you think about the cost of acquisition or looking at the number of employees in the organization, and it's just not scaling at the same rate. And so, when you're only growing the number of employees by 6% while the business is growing 24%, yes, you're going to see margin improvement. And that's what you're seeing here where Google services reported nice continued margin improvement. This is just an amazing asset. I mean, you're talking about 40% plus margins. Most businesses struggle to get, you know, single digits to teens. I I did a video earlier today talking about Danaher and how they have one segment that does over 40% margin.

[00:03:41]So, that when you see something like 40% margins, that's that's a sign to you.

[00:03:45]There's something really special here.

[00:03:47]And so, you know, I'm not going to dig into all the reasons why you know, their their Alphabet and their their search properties are exceptional, but the numbers sort of jump off the page with 40% plus margins. Google Cloud also showing this huge jump in profitability from around 21% margin to 35%.

[00:04:06]This is a question that investors are going to need to ask themselves, which is how much of this is due to peak pricing, how much of this is just due to a surge in demand where Amazon for several years with their AWS segment was sort of bouncing around between 20 to 30% margins. How much of this is just the fact that you've had this surge and you can get peak pricing.

[00:04:27]Is there a future, let's say, in the next few years where maybe that mean reverts back to 20%? Not sure. That's something that investors need to think about, you know, in the years ahead in terms of what their long-term margins look like. Uh you could see they're investing a lot in terms of general organization. You know, so this is, you know, corporate costs around $6 billion per quarter. And so overall, their core profitability around $40 billion per quarter and the core profitability, their margins also expanding. So this is a lot of what investors like to see. And there are some additional incremental insights that are getting investors both excited but also leading into some of the caution. One of which is that their TPUs, their tensor processing units, that's becoming a product where they are starting to recognize sales from this.

[00:05:16]So this is about delivering some of their custom AI chips into customer data centers. So it's not just through Google Cloud. This means that Google is becoming more of a semiconductor business. At least that's one of my takeaways as I'm looking at this, you know, competing more directly with someone like Nvidia. They also talked about one of my key concerns that I've had over the last year or so, which is, you know, is AI going to cannibalize their business? They talk about how AI mode surpassed 1 billion monthly active users. And they're suggesting that it's driving more total searches and sending billions of clicks to websites each week. So, they're suggesting, and the number support it, that it's additive to search. When you're seeing that 15% continued growth, it's not, let's say, purely cannibalistic. It's an additive where people are spending more time on Google properties. However, Gemini, which is their leading AI model, while they claim it's at the frontier, the reality is they recognize it needs improvement. You know, where you're looking at many different models. I recently did a video calling out the the Chinese open-source model Kimi K3 as leading the pack. And this does make a lot of investors go, "Wait a second.

[00:06:27]What's Google spending their money on if Chinese models can distill, let's say, what's going on with Anthropic and leap ahead?"

[00:06:35]This also means that they're going to have to invest a lot more just to be at the bleeding edge. And they've talked about how Gemini 4, the next upcoming model, is already in pre-training. And future frontier models may need to be larger, more data, more investment in the running of the the pre-training of these models. And so, this would mean a lot of money that's going to need to get invested. Now, brief pause on that idea. I think it is worth exploring that even if, let's say, Google constantly lags behind, let's say, OpenAI, Anthropic, and let's say some Chinese labs like Moonshots, and you know, they do not they they are not constantly at the frontier, they might still be fine because they have the distribution to billions of users. So, they could say, "You know what? We're just going to roll out our models, and because people are already using it, they don't necessarily need the cutting-edge. Maybe they're using the cutting-edge in other use cases, but we're going to use the AI that we have, which might be quite good, maybe not the very best, but quite good, we can roll it out to billions of users and create a magical experience that reinforces their usage, further driving their product.

[00:07:50]So, that is I'd argue the bull case with Gemini and with Alphabet more broadly.

[00:07:56]However, the recognition that they are behind means they're going to be spending more on capital expenditures.

[00:08:02]They're raising their outlook for the year to around 195 to 205 billion. So, let's call it 200 billion in capital expenditures. They're saying that, "Look, we we plan to expand the use of third-party capacity in third quarter while we build out more internal capacity." They're They are capacity constrained given the strong demand from AI. However, this is what gives investors pause is saying, "Yeah, we expect around 200 billion in expenditures, this capital expenditure, servers, data centers."

[00:08:31]However, we expect it to increase significantly in 2027. So, maybe this goes from 200 billion to 250 billion.

[00:08:40]And that does give investors pause when you're like, "Wait a second. I thought I was just looking at your quarterly profitability around 160 billion annualized, and you're talking about maybe going to 200 to 250 billion. How much cash burn, how much capital are you going to need to raise in the years ahead?" And just in this quarter, they raised around $75 billion through common stock, preferred stock, and debt. And then, add more to to to this pile of cash that they're raising. They're saying, "Look, we are we're a we could be in the market to sell an additional 40 billion dollars in stock." So, that is part of the reason why the stock, I'd argue, is coming under pressure as investors going, "Wow, how much money are they going to have to raise? How much stock will they have to sell to finance this just tremendous project?" So, is Alphabet stock on sale even with the sell-off? First of all, recognize none of this is financial advice. This is just some of my musings on the company.

[00:09:41]Also, a quick plug. Earlier today, Philip V wrote, "Daniel, I've been subscribed to your service for a very long time and I really love it. I think you're doing an amazing job." He's talking about Unrivaled Investing.

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[00:10:05]And so, when I think about Alphabet right now, around $330 per share, around $4 billion market cap, this is a hypothetical framework. Of course, stock prices can go higher or lower.

[00:10:17]But, when I look at this, I think their core Google services segment is going to be around $4 billion of the value.

[00:10:25]So, that means if you're really banking on a great return or a less great return, it's really going to depend on that cloud segment. And so, looking at this, this framework gets me to roughly flatish, maybe a little bit better, and possibly teens over the next 5 years.

[00:10:43]But, the teens requires just dramatic just almost heroic assumptions. And we'll we'll talk about that in just a second. You could talk about these different pieces here. I'm going to focus for this video on the cloud segment. Other bets, this might be dramatically off. I'm assuming somewhere between 100 to 300 billion dollars. I mean, they they have you know, Waymo, they have Calico, which is a research lab, you know, that's looking to effectively the fountain of youth sort of thing. And we're seeing some news from that. So, you know, there are questions of what what will these be worth? You know, if you're able to solve aging, arguably that's worth a lot more than 300 billion dollars. So, you have those dynamics playing out, you know, solving disease.

[00:11:26]That that would obviously be worth a lot more than 300 billion dollars. You know, that that would make the bull case much better. So, I I view this as this is my framework. I'm trying to be reasonable in the assessment. I'd love your comments below, but let's let's go through their cloud segment in greater detail because what investors have seen over the last few years is an acceleration going from 26% growth to 30% growth to 36% growth.

[00:11:52]Now, talking about closer to 80% growth in the most recent quarter. And my look at this is maybe they're on track to around 80 billion or 80% growth, somewhere between 70 and 80% growth this year, ballpark, recognizing that they grew 60% in the first quarter. And, you know, maybe I'm being too conservative here. Maybe you would say, you know, Daniel, it should really be closer to 80% and 90% here. The bigger question is what does the sales and margins look like let's say in 5 years from now because I'm assuming that the 35% jump in margins, you know, where it's gone from closer to 20% to 35%. I'm not so sure how sustainable that is. And if you get back to let's say 30%, I mean, all this capital in the world is going into, hey, we got to build out these data centers.

[00:12:40]Could you see, let's say, it go back to 30%, which is where AWS was for several years. Actually, AWS was even lower than that before the the AI sort of hockey stick higher. And then also thinking about their growth in the years ahead, it is important to recognize the backlog for this business. Last year, their backlog, which is predominantly cloud, was 106 billion. Last quarter, they talked about it being 462 billion. That was the huge increase that caused everyone to say, "Holy moly, this is a new era for our of butt stock." And that I think was part of the reason why it did so well following first quarter results.

[00:13:17]However, now you look at the current backlog and it's around 514 billion. So, that is a significant deceleration relative to what we've seen.

[00:13:28]Now, thinking about $514 billion in backlog, management says they expect to recognize 50% plus over the next 24 months. So, that does get to around $129 billion per year. So, that would suggest, you know, a further step up of let's say 20% 30% next year versus what I'm penciling out. But, the trickier part is that if you're thinking about this over 5 years, which is how I prefer to think about all investments is some sort of, you know, sort of medium-term framework, 5 years.

[00:14:01]Where I'm looking at this some someone would argue that's closer to long-term.

[00:14:06]You know, I'm I'm saying over the next 5 years, maybe it gets to 255 to 300 billion dollars in annual sales. The challenge is, you know, getting there would effectively mean that they would need to you know, effectively double again from where they are today. And that's after this huge jump in the backlog.

[00:14:26]Now, it's possible it happens, but it that is quite an assessment. That is quite an assumption to believe, you know, what? This this business you're going to go from 100 billion dollars in sales to 300 billion dollars in sales over the next 5 years. Personally, I think that's pretty darn aggressive, and that's what's required, in my opinion, to get to a just a teens type of return for Alphabet. Now, admittedly, that's a high teens type of return. But, if you assume more conservative assumptions, like only let's say 20% annual growth for cloud, which still is quite an aggressive assumption, in my opinion, then you'll, you know, folks might say, "Daniel, wait a second. It's growing closer to 80% the most recent quarter.

[00:15:09]20% over 5 years, isn't that, you know, not super super aggressive?"

[00:15:14]My view is you always need to think about these over multiple, you know, time multiple years. I mean, that still assumes the business more than doubles from here.

[00:15:22]You know, so that's that's the part that's tricky is that you would need to see a real step up in the backlog that didn't happen in the most recent quarter. If anything, the deceleration in the quarter might cause some investors say, "Wait a second, it's going to be tougher to assume that you're going to get to 300 billion, let's say, 5 years from now." Cuz keep in mind, this backlog is a multi-year backlog, like a I'd assume around a 4-year, maybe 5-year backlog. When you're talking about you know, the contracts, you know, they sign a cloud contract and then this is what That's the the backlog is the figure they're expecting over multiple years. So, all of a sudden, you're saying, "Hey, we have a backlog of 500 billion, and, you know, the goal is to get to, let's say, 300 billion annual sales."

[00:16:05]That would require a backlog of, you know, a trillion, trillion plus just to just to get to that, you know, 1 and 1/2 trillion. So, that's the the concern is you would need to see further, you know, jump in the backlog to really get that this hyper, you know, bull case that only gets to a teens type of return, a high teens type of return for Alphabet. If you assume a more conservative approach, which I once again, it assumes the business just doubles going from 100 billion to 200 billion, then, you know, you're talking about a scenario where it might only end up, you know, flat over the next 5 years. So, that is part of the reason why I'm cautious thinking about Alphabet from here is What What are the assumptions investors are using in order to justify, let's say, more than a high single-digit type of return? Because I can get to a high single-digit. It It does require some some tough assumptions, like 20% annual growth, 30% margins, over 30 times multiple 5 years from now. So, those those are pretty aggressive. And if you don't get that, you know, then you are talking about flat and what if there's a recession? What if ad ad spend starts pulling back? So, those are the the challenges that I think investors need to to consider because I look at this and I'm not overwhelmed by the valuation looking at Alphabet here even after the sell-off. That said, I'd love to hear your thoughts if you think I'm being overly conservative on Alphabet, please let me know in the comments below.

[00:17:41]Thanks so much for tuning in to Unrivaled Investing.