Share prices of Alphabet (GOOG +2.22%) (GOOGL +2.12%) tumbled following the release late Tuesday of its third-quarter results. Most of its businesses are doing well enough, but its cloud computing segment fell short of expectations over reports of slowing growth.
You might want to use the stock's sizable pullback as an entry opportunity, though. The market is mostly missing a handful of details about the company's cloud business.
What most investors overlook about Alphabet
Alphabet turned $76.7 billion in revenue into earnings per share (EPS) of $1.55 during the third quarter ending in September. Both figures are measurably up from year-earlier levels, and both beat analysts' consensus estimates of $76 billion in sales and EPS of $1.45.
Cloud revenue of $8.41 billion, however, was below forecasts of $8.64 billion. Year-over-year growth of 22.5% is the slowest this segment has produced in several years, further undermining the stock.
But there's more to the story. Here are three things about Google Cloud you'll want to understand before jumping to any conclusion about the unit's health.
1. Last quarter's comparison is an unfair one
Yes, Google Cloud's revenue growth slipped in the third quarter. But the slowdown was largely due to the fact that as the company's cloud business has grown, the comparisons are getting tougher and tougher. In absolute dollar terms, Alphabet's cloud computing has been growing at the same pace since 2020, as the chart below illustrates.
Data source: Alphabet. Chart by author. Revenue and operating income figures are in billions.
In fact, last quarter's slower growth rate of 22.5% is arguably a bit exaggerated. Take a closer look at what happened in the third quarter of last year. Cloud revenue uncharacteristically jumped, making this year's third-quarter comparison more challenging.
2. Cloud profit growth will improve soon, and dramatically
While the cloud operation turned profitable in the first quarter of this year and has remained in the black in the meantime, its actual profits aren't exactly riveting. Only $266 million of last quarter's $8.4 billion in cloud revenue was turned into operating income. That translates into a profit margin of about 3.1% -- pretty meager.
This isn't the norm, though. Google Cloud has spent most of its life in the red not because it's being run poorly, but because it lacked the scale that spreads its fixed costs around. It has a lot more scale now, and it will gain even more.
NASDAQ: GOOG
Key Data Points
We don't know exactly how much net income to expect from Google's cloud business in the foreseeable future, but we can get an idea about what's in store by looking at a major cloud computing competitor's profitability. Amazon's web service operating margin is about 25%. Alphabet's should be in the same ballpark, meaning the business could soon boost the company's bottom line by billions rather than millions.
3. It's winning a bigger share of a growing market
Lastly, while Google Cloud's growth is slowing on a relative basis, the company is still doing better than most, including Amazon.
The third quarter's final numbers aren't yet tallied. As of the second quarter, the technology market analytics firm Synergy Research reports Google Cloud controlled 11% of the worldwide public cloud computing market. That was up slightly from the 2022 first-quarter and second-quarter shares of 10%, and firmly ahead of the 2020 second quarter's 8% share and 2019's second-quarter share of 7%.
It's slow slogging to be sure, but it's progress. Meanwhile, Amazon Web Services' share of the cloud computing industry is far bigger at 32%, but it's been stagnant since 2018. So Alphabet is clearly doing something right.
Data source: Synergy Research Group. Chart by author.
In the meantime, the cloud market itself continues to grow. Straits Research believes that worldwide, it is set to grow at an annualized pace of more than 17% through 2031, agreeing with outlooks from Mordor Intelligence and Precedence Research.
Google stock is set for a big rebound, and soon
Any disappointing result from a company's business segment should be explored. Most big problems start out as small ones.
However, the market has arguably lost perspective on Google Cloud's third-quarter results, seeing a serious problem where there isn't one. Besides, even if last quarter's growth represents the new norm for Google Cloud, it still only accounts for around 11% of companywide revenue, and total revenue was still up 21% year over year during the quarter in question. Better yet, the third quarter's operating income was up by more than 24%.
Just don't tarry if you believe most investors are currently making more out of Google Cloud's quarterly slump than is merited. The bullish information discussed here is not difficult to spot by those just willing to look for it. Alphabet stock could be due to bounce back sooner rather than later.
