Why You Should Buy the Post-Earnings Dip in Alphabet

Stocks to buy

Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) got left behind last week. While Big Tech names rallied after earnings, Google stock declined over 3% on Friday.

the google play store, youtube and gmail apps on a cellphone screen

Source: BigTunaOnline/Shutterstock.com

The divergence seems somewhat surprising. Google’s revenue and profits unsurprisingly took a hit from the pandemic. But the numbers handily beat Wall Street expectations. And commentary from management suggests the news is getting better every week.

Meanwhile, it’s not just the gap between Google stock and other tech titans that is surprising. Alphabet sits at the intersection of trends that are leading other stocks in the market to soar. But Alphabet not only underperformed last week, it has done so this entire year.

I believe that will change, and potentially quickly. I’ve been a bull on Alphabet for some time now, and nothing in last week’s earnings changed my mind. If anything, the reaction to reports elsewhere in tech suggests that Alphabet’s stock may have further to rally than even I thought.

Earnings Are Better Than Feared

Admittedly, Alphabet’s second quarter earnings weren’t great. Revenue declined year-over-year for the first time ever. Earnings per share fell 29%.

But these numbers are no surprise. Business closures throughout Q2, driven by the novel coronavirus pandemic, crushed demand for online advertising. Of course, that’s Alphabet’s core business.

And performance did get better as the quarter went on. Per the second quarter conference call, search revenue had improved to flat by the end of June. In March, by comparison, the category was down “mid-teens.”

Simply put, this is not a quarter that is reflective of Alphabet’s potential. But even in a quarter impacted by an unprecedented, worldwide, pandemic, Alphabet still generated $7 billion in net income and over $8 billion in free cash flow.

And, again, performance improved as the quarter went on. It will continue to do so as 2020 rolls on.

Google Stock Slides

Yet investors sold the news, with Google stock declining over 3% in trading Friday.

It’s not just that the stock declined. It’s that other tech titans rallied. Amazon (NASDAQ:AMZN) gained 3.7%. Apple (NASDAQ:AAPL) soared over 10%, and Facebook (NASDAQ:FB) climbed 8%.

The divergence seems to make some sense, given notably different earnings results. Those other tech giants saw revenue increase as a result of the pandemic. Even Facebook, likely Google’s main rival in online advertising, saw its top line rise 12%.

But the pandemic provided a short-term boost to those companies. Facebook, for instance, saw engagement increase amid “stay at home” orders.

Google had no such tailwind. Yet it still delivered decent results, all things considered. And where the company did see some short-term benefit, it delivered.

After all, despite lower pricing, YouTube ad revenue increased almost 6%. “Other” revenue for Google, which includes YouTube TV, rose more than 25%.

And, most notably, Google Cloud outgrew Amazon and nearly matched Microsoft (NASDAQ:MSFT) with a 43% jump year-over-year.

Google’s business is fine. Yet Google stock is now 7% cheaper than it was just a couple of weeks ago.

Looking Elsewhere

What’s more surprising is that Alphabet now has rallied just 10% so far this year. That’s far and away the worst performance of mega-cap tech plays. The other so-called ‘“FAANG stocks” plus Microsoft on average have gained 44% in 2020.

That performance seems to be a case of the market focusing on near-term ad pricing headwinds and ignoring the long-term tailwinds behind Alphabet’s business. After all, the trends boosting the market as a whole all will be beneficial for Alphabet’s results going forward.

For instance, e-commerce names have soared, with AMZN joined by the likes of Wayfair (NYSE:W) and Overstock.com (NASDAQ:OSTK). E-commerce growth should boost Google, particularly with management on the Q2 call talking up the company’s efforts in that category.

Optimism toward the cloud is huge. Alphabet is third in that category behind Microsoft and Amazon.

Self-driving cars? The Waymo business remains a leader. Artificial intelligence? Alphabet is leading the way.

Across the market, we’ve seen investors correctly take the long view. As a result, they’ve largely forgiven near-term, pandemic-driven weakness from quality companies.

Yet, for some reason, Google stock hasn’t received the same benefit of the doubt. It certainly didn’t on Friday. At some point, likely soon, that will change.

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