A Long Growth Path Ahead For Alphabet

| About: Alphabet Inc. (GOOG)

Summary

Alphabet crushes Q4 EPS estimates due to surging revenue growth.

Spending on Other Bets takes on a more aggressive phase since the hiring of the new CFO.

The stock is likely to ride the momentum of higher revenue growth toward $1,000 though unconstrained spending will eventually thwart the gains.

As predicted back in December, the now record enterprise value of Alphabet/Google (NASDAQ:GOOG)(NASDAQ:GOOGL) was no problem for the stock after reporting strong Q4 results. Due to a steady revenue stream and the advertising switch to digital means, the company appears to have a long growth path ahead.

The stock surged in after-hours trading above $800 for the first time, sending the market value toward $550 billion. The corresponding slump in Apple's (NASDAQ:AAPL) stock actually has Alphabet aligned to end Tuesday trading with the largest market cap as well as the already claimed enterprise value lead. Considering Alphabet doesn't garner a lead in key financial metrics, the market might need to consider valuation concerns going forward for one big reason.

No Adult Supervision

Alphabet has definitely re-accelerated growth since the arrival of the new CFO last year. Ruth Porat has even managed to increase operating margins slightly during her time as the top financial officer. Though her arrival has ushered in new financial reporting and disclosures to help the investment community, the financial discipline envisioned on her arrival has not occurred.

With the breakout of the Other Bets business segment, investors can now see that the division is losing an incredible $3.1 billion annually on revenues of only $448 million. Not only is the business segment spending nearly 8x revenues on those bets, but also the size of the operating loss surged $1.5 billion for a near doubling of the loss from 2014.

At the same, the stock buyback had only limited impact on the growth in diluted shares. Despite spending $1.8 billion on buybacks during Q4, the share count is up about 8.5 million shares for the year. The 2.4 million shares purchased in the quarter were totally swamped as the share count grew nearly 3 million from the average in Q3.

Headcount ended the year at 61,814, up 8,200 employees for the year and 1,800 for the quarter. Most notably, stock-based compensation grew $235 million from last year in another sign that no discipline exists.

If anything, the better financial metrics are based on accelerating revenue growth from YouTube and mobile search and possibly has nothing to do with financial discipline from the new CFO. Based on the below statement, the hiring of the new CFO and the breakout of the Other Bets division was met with accelerating spending and losses.

Click to enlarge

Source: Alphabet Q4 earnings release

From Q2 to Q4, the loss from the segment grew from $574 million to $1.1 billion. In reality, the Google segment saw operating income surge to $8.0 billion from $6.3 billion last year. The self-inflicted wounds caused the reported income to only grow $1.2 billion from the $5.6 billion generated last Q4. Without the accelerated losses in Other Bets, operating income would've surged an incredible 30%.

Key Metrics

At the end of the day, Alphabet isn't the largest company when considering actual financial results such as revenues and operating income. The stock only grabs the largest market cap and enterprise value due to the willingness of the market to reward Alphabet with a larger multiple for those results.

GOOGL PE Ratio (Forward 1y) Chart

GOOGL PE Ratio (Forward 1y) data by YCharts

As far as revenues, Apple is far and away the leader with $233 billion last year. Alphabet only produced a fraction of those revenues at $75 billion. Even in the more crucial operating income column, Apple still blows away Alphabet. For 2015, Apple earned over $71 billion in profits compared to only $23 billion for Alphabet.

The valuation key is the willingness of the market to pay a higher multiple for the more consistent revenue stream of Alphabet. The story likely doesn't change anytime soon, but one does need to consider that the Internet search giant could double revenues and end up with a similar stock valuation. As the market size grows, the market may not have the fire power to award higher stock prices.

Takeaway

The market will continue pushing Alphabet higher due to strong revenue growth. For now, the company is utilizing the fast growth to cover up the self-inflicted wounds from the Other Bets that aren't generating anywhere close to enough revenues to ever cover costs.

Ultimately, one has to continue riding Alphabet higher and possibly up to $1,000 at this point. The lack of financial discipline and realization that the new CFO has overseen an unprecedented increase in discretionary investments will come back to hurt the stock.

Disclosure: I am/we are long AAPL.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.