3 Things Investors Miss About Google’s Cloud Business

stock prices Alphabet (GOOG -0.03%) (GOOGL -0.09%) fell after third-quarter results came out on Tuesday. Most of its businesses are doing fairly well, but its cloud computing segment has not met expectations due to reports of slowing growth.

However, you may want to use a significant stock pullback as an entry opportunity. The market is largely missing a number of details about the company’s cloud business.

What do most investors miss about Alphabet?

In the third quarter ended in September, Alphabet turned $76.7 billion in revenue into earnings per share (EPS) of $1.55. Both numbers were modest from year-ago levels, and both beat analysts’ consensus estimates of $76 billion in sales and $1.45 EPS.

Cloud revenue of $8.41 billion was below forecasts of $8.64 billion. The 22.5% year-over-year growth is the slowest this segment has produced in several years, further undermining the fund.

But there is more to the story. Before you jump to any conclusions about the partition’s health, there are three things you’ll want to understand about Google Cloud.

1. The comparison of the last quarter is unfair

Yes, Google Cloud’s revenue growth slowed in the third quarter. But the slowdown was largely due to tougher comparisons as the company’s cloud business grew. In absolute dollar terms, Alphabet’s cloud computing has been growing at the same rate since 2020, as shown in the chart below.

Data source: Alphabet. Graphic by the author. Revenue and operating income are measured in billions.

In fact, last quarter’s slower growth rate of 22.5% is certainly a bit of an exaggeration. Take a closer look at what happened in the third quarter of last year. Cloud revenue grew uncharacteristically, making this year’s third quarter more difficult to compare.

2. Cloud profit growth will improve soon and dramatically

Although the cloud operation was profitable in the first quarter of this year, its real profits so far have not been encouraging. Of last quarter’s $8.4 billion cloud revenue, only $266 million was converted into operating income. This translates to a profit margin of about 3.1% – pretty meager.

Although this is not the norm. Google Cloud spent most of its life in the red, not because it was poorly run, but because it didn’t have the scale to spread its fixed costs around. It has more scale now and will earn more.

We don’t know exactly how much net revenue to expect from Google’s cloud business in the near future, but we can get an idea of ​​what’s in store by looking at the profitability of a major cloud computing competitor. Amazonweb service operating margin is about 25%. Alphabet’s should be on the same playing field, meaning the business could soon increase the company’s revenue by billions, not millions.

3. It gains a larger share of the growing market

Finally, while Google Cloud’s growth has slowed on a relative basis, the company is still doing better than most, including Amazon.

The final figures for the third quarter have not yet been calculated. As of the second quarter, technology market analyst firm Synergy Research reports that Google Cloud controls 11% of the global public cloud computing market. That was slightly more than the 10% share in Q1 and Q2 2022, and well ahead of Q2 2020’s 8% share and Q2 2019’s 7% share.

Slowly but surely, it’s progress. Meanwhile, Amazon Web Services’ share of the cloud computing industry is larger at 32%, but has been stagnant since 2018. So Alphabet is doing something right.

Graph showing the change in public cloud computing market share since 2018.

Data source: Synergy Research Group. Graphic by the author.

Meanwhile, the cloud market itself continues to grow. Straits Research estimates that Mordor is poised to grow at an annual rate of more than 17% worldwide through 2031, in agreement with forecasts by Mordor Intelligence and Precedence Research.

Google stock is poised for a big comeback, and soon

Any disappointing results from the company’s business segment should be investigated. Most big problems start as small problems.

However, the market certainly missed the prospect of Google Cloud’s third-quarter results, seeing a serious problem where it wasn’t. Additionally, while last quarter’s growth represents the new normal for Google Cloud, it still represents about 11% of the company’s total revenue, and total revenue for the quarter in question was up 21% year-over-year. Even better, third quarter operating income rose more than 24%.

If you believe that most investors are currently getting more than they deserve from Google Cloud’s quarterly decline, just don’t delay. The superior information discussed here is not difficult to discover by those who are merely willing to look for it. Alphabet stock may return sooner rather than later.

Alphabet CEO Suzanne Frey is a member of The Motley Fool’s board of directors. John McKee, former CEO of Amazon subsidiary Whole Foods Market, is a member of The Motley Fool’s board of directors. James Brumley has positions in the Alphabet. The Motley Fool owns and recommends positions in Alphabet, Amazon and Microsoft. The Motley Fool has a disclosure policy.

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