Let me guess.
You’re reading this on an Android phone or using the Chrome browser.
Given the market dominance of the two platforms, it wouldn’t be surprising.
These popular products are both owned by Alphabet Inc (NASDAQ: GOOG), which recently announced impressive financial results for the fourth quarter of the fiscal year ending December 31, 2024 (FY 2024).
Fourth-quarter revenue increased 12% year over year to US$96.5 billion, while earnings per share (EPS) jumped by 31% to US$2.15 over the same period.
Despite this strong performance, the market reacted negatively, and Alphabet’s stock price has fallen by approximately 10% since its earnings announcement.
Two key concerns appear to be driving this reaction: lower-than-expected revenue growth in the Google Cloud segment, and the anticipated increases in depreciation and capital expenditure.
This raises the question: Is the market’s concern warranted, or does this dip present an investment opportunity in this advertising giant?
Let’s delve deeper into the two market concerns.
Google Cloud missed estimates
A look at the headline suggests that Google Cloud had a poor quarter.
That’s far from the truth.
In reality, cloud segment sales grew by an impressive 30% year on year (YOY) for 4Q’FY24, reaching a record US$12 billion.
While the YOY growth was slightly lower than the previous quarter, these short-term fluctuations are normal.
To use an analogy, it’s like penalising a student for scoring 90% on a test just because he scored 95% on the previous test.
Looking at the full year, Google Cloud revenue increased substantially by 31% YOY. It now accounts for over 12% of Google’s total revenue, a significant jump from 7.5% in FY 2021.
Though the higher contribution from Google Cloud implies that the revenue from Google advertising contributed less to Alphabet’s top line, it doesn’t mean that the advertising segment is stagnating.
In fact, both Google Search and YouTube Ads experienced strong double-digit YOY growth this fiscal year, exceeding the single-digit growth of the prior two years.
Hence, Alphabet performed exceptionally well across all segments in FY 2024.
You might wonder, though, if this momentum can be sustained, especially given the guidance on increasing costs going forward.
Increasing depreciation and capital expenditure
With the increase in capital expenditure (CapEx) over the past few years, management has guided that depreciation will accelerate in the coming years, which will inevitably impact the company’s profit.
However, this doesn’t necessarily result in a decrease in net profit. The CapEx could potentially increase the company’s future revenue, offsetting the depreciation expenses.
This is evidenced by Alphabet’s strong track record.
Despite increasing CapEx over the past three years, net income has grown at a compounded annual rate of nearly 10% over this period.
Furthermore, depreciation is a non-cash expense, meaning it doesn’t impact operating cash flow, which reached a record US$125 billion in FY 2024.
This robust cash flow and strong balance sheet position Alphabet to comfortably afford its planned US$75 billion CapEx next year.
Crucially, this investment isn’t aimless.
As the CFO noted during the earnings call, the company is seeing demand for its AI products that currently exceeds its capacity.
Get Smart: The pie is big enough for multiple winners
“But what about DeepSeek?” You might ask.
While China’s DeepSeek is indeed a player to watch, competition is a natural part of Alphabet’s business.
Established companies such as Microsoft Corp (NASDAQ: MSFT), Amazon.com Inc (NASDAQ: AMZN), Meta Platforms Inc (NASDAQ: META) are also investing heavily in AI, creating a dynamic and competitive landscape.
More importantly, the AI pie is still growing rapidly. The field is in its early innings, and this competition is likely to drive innovation beyond just LLMs, creating a larger market with room for multiple successful companies.
Given Alphabet’s massive resources, vast user base, and the immense potential of the AI market, the question remains: is this recent dip a sign of trouble, or a compelling investment opportunity?
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Disclosure: Chan Kin Chuah owns shares of Alphabet and Microsoft.
