Source: PaxForex Premium Analytics Portal, Fundamental Insight
Despite being the third-largest U.S. company, Alphabet has had a bad year. The company's stock is down 31% this year, below both the Nasdaq Composite and the S&P 500.
Despite that decline, doesn't that set the stage for growth next year? After all, you can't change the past, but you can invest in the future. So let's find out if Alphabet has the prerequisites for a recovery next year.
First, let's break down how 2022 played out for Alphabet. Alphabet's fall can be attributed to its concentration in the advertising industry. Since nearly 80 percent of the company's total revenue comes from advertising sources, Alphabet is highly exposed. The advertising business is historically cyclical; it rises and falls with the economy.
When times are good, companies spend heavily to promote their products and services. When the outlook is bleak, these companies cut back because it's much easier to control advertising spending than it is to lay off employees or cancel initiatives. Alphabet's advertising revenue grew only 2.5% in the third quarter, which is still impressive given the adversity Alphabet faced in the third quarter. There are two key findings in this metric.
First, Google's search advertising grew by 4.3%, indicating that its core product (Google search advertising accounted for 57% of Alphabet's total revenue) is still seen as a necessary advertising destination for many customers. Second, YouTube ads fell 1.9% in the third quarter, showing that social media ads don't provide the same return on investment that companies are looking for when buying ads.
Investors should keep an eye on how these metrics will change in 2023, as their direction will also determine the stock price.
But there are a few other considerations to keep in mind.
Another important indicator of Alphabet's third-quarter results was the number of employees hired over the past year. The number of employees rose from 150,028 last year to 186,779 this year, an increase of 25 percent. These new hires contributed to an increase in operating expenses, especially in research and development.
When considering research and development spending, keep in mind that Alphabet completed the acquisition of cybersecurity firm Mandiat (formerly known as FireEye), which added 2,600 new employees to Alphabet's tally. Still, where the company is spending its money is encouraging, though I wish the growth had been lower.
First, Alphabet sees opportunities in artificial intelligence, cybersecurity, and data centers, so it is investing heavily in these initiatives in exchange for lower margins.
Second, many companies are cutting back on advertising and sales during tough economic times because they can't afford it or are being fiscally conservative. In a less saturated advertising market, if you can afford to place ads, they will be more effective because there is less competition. Alphabet understands this and is ramping up spending to capture more market share.
Finally, general and administrative costs have not grown at the same rate as the more important segments. This is very important because it shows that Alphabet is not becoming a heavier company.
Nevertheless, during the report, the company's management stated that it intends to reduce the rate of hiring in 2023. Undoubtedly, this is a sensible move, and Alphabet's profitability should stabilize or improve.
While many continue to criticize Alphabet's expenses, the company still posted an impressive 20 percent profitability in the third quarter, something many companies cannot say.
Despite Alphabet's rising costs impacting earnings, the company's stock is still trading at a historically low valuation.
If the economy recovers over the next year, Alphabet stock will jump up thanks to an influx of ad spending. If it doesn't, but Alphabet maintains its revenue streams, the stock will likely stay flat, while many others will sink. With Alphabet stock still trading at a low valuation level, and thanks to other growth initiatives such as cloud computing, the future is bright for Alphabet stock and business.
However, no one knows if that reversal will happen in 2023. Nevertheless, the business is experiencing a temporary downturn, and for long-term shareholders, Alphabet is likely to provide market returns when evaluated over a time horizon of three to five years. Alphabet is a great idea, and investors should not wait until 2023 to buy the stock.
As long as the price is above 92.00, follow the recommendations below:
- Time frame: D1
- Recommendation: long position
- Entry point: 94.91
- Take Profit 1: 99.00
- Take Profit 2: 105.00
Alternative scenario:
If the level of 92.00 is broken-down, follow the recommendations below:
- Time frame: D1
- Recommendation: short position
- Entry point: 92.00
- Take Profit 1: 87.00
- Take Profit 2: 83.00
