To quell investor concerns, Google needs more than just strong performance

According to the Vast Finance APP, in recent months, the stock price of Alphabet (GOOGL.US) has been lackluster, far behind its "Big Seven" peers. Investors have been struggling to price the risks facing the company, and the hope that the earnings announced on Tuesday will dispel these concerns seems somewhat far-fetched.

The market generally expects that Alphabet's latest financial report will show that its long-term growth trend remains unchanged, and the company is also expected to provide positive new information regarding the impact of artificial intelligence.

However, even a positive financial report may be overshadowed by concerns about the unquantifiable costs of antitrust actions, dragging down the stock performance and making its valuation among many tech giants relatively low. In addition, whether Alphabet's dominant market share in the internet search field will be threatened by other participants in artificial intelligence will also be closely watched.

George Cipolloni, portfolio manager at Penn Mutual Asset Management, said, "It's easy to assess a company's valuation, but there are many unquantifiable concerns, which means you still can't determine whether this is value or a value trap. Compared to the other Big Seven, Alphabet clearly looks cheap, but relatively speaking, the return you expect requires you to take on a lot of risks."

Over the past six months, Alphabet's stock price has remained flat, making it the worst performer among large-cap stocks. In contrast, the Bloomberg Magnificent Index has risen by nearly 26% during this period.

Analysts expect Alphabet's revenue in the latest quarter to grow by nearly 14%, with net profit increasing by over 18%. It is expected that these two indicators will maintain double-digit growth rates in the coming years.

These healthy trends, coupled with its more moderate valuation, may mean that the company has a lower "threshold" to cross this quarter. Jefferies stated that Alphabet faces a "less stringent environment among large-cap stocks in terms of profitability" and the stock should "rise over time driven by fundamentals, despite facing regulatory/antitrust resistance."

Currently, the stock's forward price-to-earnings ratio is 19 times, the lowest among the Big Seven, and below its 10-year average level. In comparison, another major artificial intelligence software company, Microsoft (MSFT.US), has a valuation close to 31 times.

Due to investors becoming increasingly cautious about long-term growth prospects and demanding higher valuations, Alphabet's fundamentals and valuation discount stand out prominently among large tech companies.

However, the discount also reflects the special risks Alphabet faces. Since a federal judge ruled that Alphabet illegally monopolized the search market, antitrust regulation has become a major obstacle for the company.

Earlier this month, the U.S. Department of Justice told a federal judge that it is considering recommending Google to divest some of its businesses. While this is considered unlikely and Google is expected to face more extreme penalties, this uncertainty may still be a long-term issue.

Google remains one of the companies that invest heavily in the field of artificial intelligence, and investors are increasingly hoping to see these expenditures pay off in terms of growth and efficiency. Higher-than-expected spending was one of the reasons the stock faced selling pressure after the last quarter's performance announcement.

While artificial intelligence has boosted demand for the company's cloud computing services, Google is also taking "defensive" measures to protect its internet search market share from the impact of artificial intelligence substitutes.

According to compiled data, nearly 80% of the company's revenue in 2023 comes from Google ads. Less than 11% comes from Google Cloud. It was reported on Monday that Meta (META.US) is developing an artificial intelligence search engine to reduce dependence on Google.

Matt Stucky, Chief Equity Portfolio Manager at Northwestern Mutual Wealth Management, said, "It's hard for me to see how to eliminate these threats because I doubt the judge will give Google such a broad path, and we don't know if any erosion of market share is controllable. In terms of impacting fundamentals, these concerns are more real than ever."

Currently, about 83% of Wall Street analysts recommend buying Google, which is a positive consensus, but lower than large peers like Microsoft, Amazon (MSFT.US), or NVIDIA (NVDA.US), all of which have buy ratios close to or above 90%. However, the average target price from analysts indicates that Google will have over 20% upside potential in the next 12 months, the highest among large-cap stocks.

Stucky said, "The negative impact from regulation is unlikely to be eliminated in the short term, but at the same time, Google is a high-quality asset, its stock is trading at a discount, and its growth exceeds the market. That's the reason to stick with it."