Alphabet (GOOGL) delivered better-than-expected third-quarter sales and earnings after the closing bell Tuesday. However, Google Cloud missed and the stock sank in what we see as an overreaction. Total revenue rose 11% year-over-year to $76.69 billion, outpacing the $75.97 billion expected, according to estimates compiled by LSEG, formerly known as Refintiv. Earnings-per-share surged 46% to $1.55, exceeding the $1.45 expected. GOOGL YTD mountain Alphabet YTD Bottom line Lower-than-expected operating income for the third quarter and a Google Cloud miss dragged Alphabet shares lower by more than 6% in after-hours trading. The Google Cloud performance was particularly disappointing given the strength we saw when Microsoft (MSFT) also reported its Azure numbers on Tuesday evening. There were also mixed messages on quarterly cash flow that didn’t help sentiment. While beating estimates, it failed to reflect a $10.5 billion outflow to the IRS made shortly after the third quarter ended. It’s unclear if analysts have fully accounted for this in their fourth-quarter estimates, so investors may be taking the top and bottom line strength with a grain of salt, figuring that at least some of the Q3 outperformance was due to this deferred payment. As for Cloud, at least some of the quarterly weakness can be attributed to ongoing spending on customer optimization efforts. However, we would caution investors against getting too pessimistic on the stock. After all, the headline numbers did beat and we saw plenty of strength in advertising revenue and Google Services operating income – the bread and butter of today’s business. Plus, the Cloud is still a nascent business. There are always going to be some growing pains. However, we see no reason to stop believing that it will continue to grow over time as customer optimization efforts wrap up and artificial intelligence offerings expand. Management does expects investment to increase in the fourth quarter and into 2024 to support AI opportunities across the company. The team also hinted on the call that we could see subscription models emerge over time as another way to monetize ongoing investments in AI. Management also reaffirmed a focus on profitable growth. With the stock coming into the print only a few dollars away from its 52-week high, we aren’t surprised by the selloff — given the rise in rates and how early we are in earnings season. With big reports to come later this week, investors are likely to jump on any weakness as a reason to book some profits. We recognize that the near term could be a bit rocky — but over the long haul, we think patience will pay off. That large cash tax payment noted above will hit next quarter’s cash flow performance. But since it’s a one-time item, it will likely be forgiven by Wall Street. At about $130 per share, where the stock was indicated to open in the morning, Alphabet would trade at about 19 times 2024 earnings estimates, providing a nice cushion even if estimates come down a bit. We’re reiterating our $140 price target and maintaining our 2-rating on the stock as we look for shares to regain their footing before we were to get more bullish. Quarterly commentary Despite the topline outperformance, seen in the earnings table above, segment sales at Google Network, Google Cloud and Other Bets came up short. YouTube, however, saw strength in both ads and subscriptions, with management highlighting positive reviews for its new NFL Sunday Ticket offering. The team also noted that shorts on YouTube “now average over 70 billion daily views and are watched by over 2 billion signed-in users every month.” YouTube ad revenue, specifically, benefited from both brand advertising and direct response growth. Operating income and quarterly operating margin were also short of expectations as total Traffic Acquisition Costs (TAC) were marginally above expectations. Expenses in Google Cloud and Other Bets were higher than expected, and the company took charges associated with workforce and office space reductions. The outsized loss in Other Bets is also likely frustrating investors given the miss in operating income. It’s one thing to invest in long-shot projects when you’re hitting the numbers. But investors are going to be far less forgiving when operating income is coming up short due to those investments that won’t pay off until some unknown point in the future, if ever. Against the operating income and margin miss, cash flow generation was superb, with free cash flow coming in more than 40% ahead of what the Street was looking for. Capital returns Alphabet returned $15.8 billion to investors via share repurchases in the third quarter, partially offset by $5.7 billion in stock-based compensation. It exited the quarter with $120 billion in cash, cash equivalents and marketable securities on its balance sheet. That said, the company did have to make an estimated tax payment of $10.5 billion on Oct. 16, an outflow, as noted earlier, not reflected in Q3 results. (Jim Cramer’s Charitable Trust is long MSFT. See here for a full list of the stocks.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust’s portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. 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Alphabet (GOOGL) delivered better-than-expected third-quarter sales and earnings after the closing bell Tuesday. However, Google Cloud missed and the stock sank in what we see as an overreaction.
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