Alphabet | Fundamental Analysis | Long | MUST READ

Alphabet stock is down about 16% over the past 12 months as investors worry about the macroeconomic problems of its core advertising business. Rising interest rates and a looming recession have also put pressure on the stock.

But that short-term factor aside, Alphabet stock looks historically cheap at 21 times projected earnings. For the foreseeable future, the company will continue to dominate the markets for search, digital advertising, streaming video, Web browsing, and mobile operating systems. Although its cloud business is smaller than that of Amazon or Microsoft, it may also continue to grow.

So selling Alphabet just because its advertising business is going through some tough quarters could be a mistake. Let's take a closer look at where the tech giant's stock could be headed a year from now.

In the second quarter of 2022, Alphabet generated 81 percent of its revenue from Google's advertising business, which includes its main search engine, ad network, and YouTube site.

"The Bears argue that this business will struggle in the face of rising inflation and slowing economic growth. Google's ad business growth has certainly declined over the past year, but it is still growing year over year (YOY).

In this segment, YouTube initially grew faster than Google's search and advertising business. However, YouTube's growth slowed in the first half of 2022 as it struggled to match the post-pandemic recovery in ad sales a year earlier.

When Google's ad business weakened at the start of the pandemic in the first half of 2020, the company relied heavily on Google Cloud growth, which was offset by lockdown trends and the growing use of cloud services.

Google Cloud continues to grow at a faster rate than the advertising business, but it is also losing momentum and is not growing much faster than its larger peers. Amazon, which leads the cloud race with Amazon Web Services (AWS), increased its cloud revenue 33% from a year ago to $19.7 billion in the most recent quarter. Microsoft's total cloud computing revenue, including its Azure cloud platform, rose 28% to $25 billion in the latest quarter.

This is troubling because Google Cloud is not yet a profitable company, and it may have to offer the lowest prices and aggressive promotions to keep up with Amazon and Microsoft. Simply put, it's not a solid crutch for Google to lean on if its advertising business ever stagnates - because an increased share of cloud revenue would likely result in lower overall operating margins.

Alphabet expects its advertising business to continue to face difficult comparisons with the recovery from the lock-in through 2022. The company also expects the growth rate of its cloud business to slow in the near term as macroeconomic factors will cause some customers to either spend less money or put off purchases.

Alphabet hasn't provided exact projections for the rest of the year, but during a recent conference call, CEO Sundar Pichai said the company will "slow down hiring and increase its focus." In other words, the company is preparing for a slowdown by cutting back on fat but expects total capital investment to increase in 2022.

In 2021, Alphabet's revenues and earnings were up 41% and 91%, respectively, as the company recovered from the pandemic. But this year, analysts expect the company's revenue to grow 13% and profits to fall 8% from this difficult period. In 2023, they expect revenue and profits to grow 12% and 16%, respectively -- assuming the current risk factors subside.

We should take these estimates with caution, but they indicate that Alphabet's slowdown is likely to be temporary, and its core businesses will continue to grow. Alphabet stock is unlikely to take off in the next 12 months - because at the moment it just seems reasonably valued, not undervalued - but it will definitely go up in the next few years.

Commentaire: