Is this the canary in the coalmine? Or just another thing for bears to fret over while the bull market marches on?
From The Wall Street Journal:
‘Investors sent shares of Google parent Alphabet Inc. to their worst day in 6 1/2 years, punishing the stock after its quarterly results signaled growth is slowing at the search-engine giant.
‘The shares closed down 7.5%, their largest one-day decline since October 2012, after earlier falling as much as 8.7%. The decline erased a sizable chunk of Alphabet’s 2019 advance, putting the stock up 15% for the year, compared with the S&P 500’s 18% year-to-date rally.
‘Tuesday’s slide came after the company shocked analysts and investors with a rare miss to quarterly sales and profit. Perhaps more worrisome for Alphabet investors, the figures showed growth cresting across the company’s business units, and top executives wouldn’t say much about the reasons for the slowdown.’
In more normal times, this would worry investors. But we are not in normal times. The Dow and S&P 500 shrugged off the miss from Google, finishing the overnight session up marginally.
The NASDAQ though, fell nearly 1%, which is not surprising given Alphabet Inc’s listing on the tech heavy exchange.
There are a few ways to interpret this news.
Why aren’t investors concerned about Google’s fall?
Firstly, on the positive side, first quarter revenue growth came in at 17%, which is still quite robust. It indicates the continuing strong growth of the digital advertising market.
On the other hand, it was the slowest quarterly rate of growth since 2015. This tells you two things: that the global economy is slowing and Google’s digital advertising business is maturing.
You can see the trend of slowing revenue growth since the start of 2018 in the graph below:
Revenue growth is an important indicator for a company because it tells you how fast it is growing. This growth is a combination of overall market growth as well as increases in market share.
So if a company grows revenue by 10%, but its overall market expands by only 5%, you know that it’s taking market share from competitors.
According to emarketer.com, global digital ad spending will increase 17.6% in 2019. That’s down from 21.4% in 2018. By 2023, the forecast is for market growth to slow to 8%.
So, the fact that Google’s first quarter revenues for 2019 grew 17%, against forecast market growth of 17.6%, suggests that it is losing market share.
According to Statista.com, Google had a 33% share of the global digital advertising market in 2017. In 2019, it’s forecast to have 32.3%.
Google’s overall market growth is slowing
So Google’s overall market growth is slowing, and competitors (namely Amazon) are chipping away at its market share.
With this in mind, parent company Alphabet trades on a rather hefty price-earnings (P/E) multiple of 28 times expected earnings for the year ending 31 December 2019. Consensus earnings growth forecasts for this year are only 6.3%, increasing to around 17% in 2020, and 14.5% in 2021.
But given the slowdown in top line growth just reported, perhaps these growth expectations will be wound back soon?
So the question for the market, given that Google is a market barometer, is whether 28 times earnings is a ‘fair’ price to pay.
One way to look at this question is to invert the P/E number to get the earnings yield.
1/28 = 3.5%
Therefore, if you pay current prices and Google meets forecast earnings expectations, you’ll earn a yield of 3.5%. If it misses those expectations, the actual earnings yield will be even less. For comparison, you can earn a 2.5% yield on 10-year US treasury bonds.
That, in my view, represents a very thin ‘equity risk premium’. This ‘premium’ is what equity investors should theoretically earn over and above long-term treasury yields for taking on the additional risk of investing in stocks.
Academics devote way too much time trying to work out what the equity risk premium is, or should be. And then they still say it is very uncertain.
So let’s keep it simple. An expected equity risk premium of 1% on a bellwether stock is not good enough for serious investors. Yes, earnings are growing. But by 2021, where earnings are expected to rise 14.5% year on year, the earnings yield is still only 4.8%. And that’s assuming analyst’s rosy growth forecasts are not interrupted by a global slowdown.
This is what happens when central banks try to coerce investors back into the market by promising low interest rates. In their fervour, ‘investors’ forget golden investment rules, like ‘risk and reward’.
They buy because everyone else buys. Stocks are rising so, quick, hurry up and get in!
This always feels good and the right thing to do in the short term. We are wired to behave with a herd-like mentality because there is safety in numbers. But when you’re playing in the stock market, you will eventually be severely punished for displaying such behaviour.
Nearly everything in the market is counter-intuitive. That’s especially the case now, as global markets hover around all-time highs.
Editor, The Rum Rebellion
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