Alphabet: Don't Get Confused

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About: Alphabet, Inc. Cl A (GOOGL), GOOG, Includes: AMZN, MSFT, T, VZ
by: Stone Fox Capital
Summary

Use of only GAAP numbers causes confusion with quarterly numbers from Alphabet.

Very high stock-based compensation charges hides otherwise large earnings.

The stock trades at about 13.5x new '20 non-GAAP numbers, ex-cash.

Right along with my previous complaints with the Q3'18 numbers, Alphabet (GOOG) (GOOGL) reported one of the most complex quarterly results to decipher this week. The internet search giant regularly has substantial one-time income and charges that detract from the operations leading to a confused investor base. The adjusted results continue to support a much higher stock price, though the spending levels remain out of control.

Android 9 Pie Image Source: Google website

Confusing Numbers

As par for the course, a company providing less information to investors typically leads to worse outcomes. Accounting purists that only want GAAP results that include a lot of one-time charges somehow convinced Alphabet to drop reporting non-GAAP numbers back starting with 2017 results. Unfortunately, the company doesn't understand what investors really want is both GAAP and non-GAAP numbers.

The ironic part is that Alphabet will actually report adjusted numbers when the quarterly results include a large one-time fine. It makes no sense to make such an adjustment without returning back to full non-GAAP numbers.

Because of the way Alphabet reports quarterly numbers, the company causes the following news tidbits from sites like Seeking Alpha that just aren't comparable to any analyst expectations. A large cap like Alphabet that beats revenues by only 1% of revenues shouldn't ever beat EPS estimates by $1.91 or nearly 18%.

Source: Seeking Alpha news

Investors aren't helped as the big beat is almost entirely related to a $1.9 billion gain in Other income, up from only $354 million in the prior Q4. Even worse, the internet search giant reported GAAP numbers that showed a $4.35 per share loss last Q4. The inability to easily compare EPS numbers is not helpful to shareholders.

Source: Alphabet Q4'18 earnings report

What really matters to investors is that revenues grew by 23% on a constant currency basis and operating income grew slightly to $8.2 billion. The Other income line was greatly impacted by a nearly $1.3 billion boost in a gain on debt securities. Excluding this amount, Other income was about $617 million in Q4'18 and $367 million last year. The majority of the remaining income is related to $523 million in legitimate net interest income. Some of the other totals might normally be excluded from a non-GAAP income and EPS number, but the numbers are all immaterial.

In addition, investors would like to see stock-based compensation excluded for both periods. Alphabet spent $2.3 billion last Q4 and $1.8 billion in the prior period.

Even worse, investors would normally look at cash flow numbers, but the huge ramp in capital spending for cloud computing has reduced the ability to focus solely on free cash flows. Investors can naturally look at cash from operating activities that jumped to $13.0 billion from only $10.3 billion in the prior Q4.

Ultimately, Alphabet should expand on this supplemental information to provide investors with a meaningful EPS. The Google operating income of $9.7 billion is reflective of a better figure for analyzing the value in the stock. The number was up from $8.6 billion last year.

Source: Alphabet Q4'18 earnings report

The company has aggressively ramped up capital spending in the last year. The huge increases now has Alphabet spending far more than the large telecoms of AT&T (T) and Verizon Communications (VZ) and the other tech giants of Microsoft (MSFT) and Amazon (AMZN).

Chart Data by

YCharts

For the full year, Alphabet had $48.0 billion in operating cash flows. This number even includes a sizable loss in Other Bets that reached $1.3 billion in the quarter, up nearly $500 million from last year. These categories offer potential for increased profitability such as via a Waymo spin off, but an investor has to be willing to except larger losses in the short term to invest for the future.

Non-GAAP Model

Ultimately though, the non-GAAP EPS number is the best guide of what the company is generating to reward shareholders. One way to look at a non-GAAP model is to take analyst estimates for 2019 and 2020 and strip out the non-cash charges. In this case, analysts are now at $47 per share for 2019 and $55 per share for 2020.

Chart Data by

YCharts

With GOOGL trading at $1,106 at the close on Thursday, the stock trades at about 20x '20 EPS estimates. This number has a couple of prime valuation problems including the SBC charges and the $105 billion net cash balance.

Going back to my previous work, Alphabet was forecast to boost non-GAAP EPS in 2018 by about $10 and a general assumption of $13 for 2019. Using that number, the company would generate an EPS of ~$60 in 2019.

Rechecking the numbers, the SBC for 2018 was $9.4 billion and increased about $1.7 billion for the year. Another 20% hike would place 2019 SBC at $11.3 billion

A similar hike in 2020 would place SBC at $13.5 billion. Using 700 million shares outstanding and a 15% tax rate, Alphabet would add about $16.40 in additional EPS to the analyst target of $54.79 for a total non-GAAP EPS target of ~$71.

Factoring in $105 billion in net cash and the company has $150 per share in cash. Using the enterprise value of $956 per share, the stock now trades at only 13.5x my new '20 EPS estimate.

Takeaway

The key investor takeaway is that Alphabet remains incredibly cheap as the market will slowly move towards looking at '20 numbers. The company continues causing massive damage to the stock valuation via not excluding these one-time charges, especially the substantial SBC charges that will likely top $10 billion this year.

Alphabet remains a stock to own.

Disclaimer: 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.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GOOGL over the next 72 hours. 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.