Alphabet Inc. (GOOGL) is trading lower by more than 3% in Friday's session, despite beating second quarter 2020 top- and bottom-line estimates. Earnings fell 29% year over year to $10.13 per share, $1.90 better than expectations, while revenues dropped 1.7% to a better-than-expected $38.2 billion. Weak ad spending and search activity undermined quarterly metrics, dropping 9.8% year over year, with customers forced to cut ad budgets as a result of the COVID-19 pandemic. 

Key Takeaways

  • Advertising revenue shrunk during the quarter, with the pandemic forcing customers to reduce ad budgets.
  • Alphabet posted the first year-over-year revenue decline in company history.
  • The two-year expanding wedge pattern on the stock chart adds considerable downside risk.

CFO Ruth Porat noted that ad revenue "gradually improved" during the quarter but said that it was "premature" to gauge the durability of the uptick. Google Cloud revenue rose a healthy 43% year over year, easing the impact of advertising losses, while YouTube and Google Play offered additional bright spots, with notable increases in user interaction, subscribership, and downloads. The company also authorized an additional $28 billion in buybacks of the Class C stock.

Wall Street consensus remains highly bullish despite Alphabet's cyclical vulnerability, maintaining a "Strong Buy" rating, based upon 26 "Buy" and just 3 "Hold" recommendations. No analysts are recommending that shareholders sell positions at this time. Price targets currently range from a low of $1,237 to a Street-high $1,990, while the stock opened Friday's session more than $200 below the median $1,710 target.

A cyclical stock is a stock whose price is affected by macroeconomic or systematic changes in the overall economy. Cyclical stocks are known for following the cycles of an economy through expansion, peak, recession, and recovery. Most cyclical stocks involve companies that sell consumer discretionary items that consumers buy more during a booming economy but spend less on during a recession.

Alphabet Long-Term Chart (2007 – 2020)

Long-term chart showing the share price performance of Alphabet Inc. (GOOGL)
TradingView.com

The stock broke out above the 2007 high at $373.62 in the first quarter of 2013, entering a strong uptrend that that eased into a rising channel in 2014. Price action held within those boundaries into October 2018, when a selloff broke channel support and fell into the March low in the triple digits. Buyers returned in early 2019, but the uptick failed quickly, yielding a successful test at horizontal support in June.

The stock returned to channel resistance in February 2020 and sold off with world markets, dropping back to horizontal support for the fourth time in two years. It bounced strongly through the second quarter, reaching the rising highs trendline once again in mid-July. The stock opened about 90 points below that barrier on Friday morning, continuing to carve an expanding wedge, also known as a broadening formation, that has a well-earned bearish reputation.

A broadening formation is a price chart pattern identified by technical analysts. It is characterized by increasing price volatility and diagrammed as two diverging trendlines, one rising and one falling. It usually occurs after a significant rise, or fall, in the action of security prices. It is identified on a chart by a series of higher pivot highs and lower pivot lows.

Alphabet Short-Term Chart (2018 – 2020)

Short-term chart showing the share price performance of Alphabet Inc. (GOOGL)
TradingView.com

The on-balance volume (OBV) accumulation-distribution indicator has acted better than price action so far in 2020, breaking out in May and posting a series of new highs. Alphabet stock has carved two failed breakout attempts at the same time and is now trading well below the February peak. This marks a bullish divergence, predicting that price will eventually follow OBV to new highs. However, that isn't in the cards on Friday, with an aggressive selloff in progress.

The stock will face additional resistance at the wedge top if it can mount the February high. As a result, it makes sense for sidelined investors to stand aside until a buying spike lifts above the $1,600 level. Conversely, the pattern adds considerable risk on the downside, raising the odds that a decline will carry all the way down to horizontal support. That could prompt sleepless nights for shareholders, with support 500 points lower than this morning's opening print.

The Bottom Line

Alphabet stock is trading sharply lower on Friday after the internet giant reported the first year-over-year revenue decline in the company’s history.

Disclosure: The author held no positions in the aforementioned securities at the time of publication.