Over the last six months, rising inflation and possible interest rate hikes by the Federal Reserve have sent the market into a slump. High inflation often crushes both growth and earnings, driving investors to sell stocks in anticipation of that plunge. But Alphabet (GOOGL +5.10%) ranks among a few select stocks built to withstand inflation. Here are three reasons why Alphabet can survive and thrive while the rest of the market retreats.
1. Alphabet protects its margins
When inflation rises and the economy surges, businesses tend to generate lots of cash. To keep their growth going, they often plow that cash back into advertising. And if those businesses want the biggest bang for their advertising buck, few companies can supply it as well as Alphabet. Rising demand for ads, coupled with Alphabet's commanding market share and convenient, advertiser-friendly features, gives the company the pricing power it needs to raise prices faster than inflation, preserving its profits in the process.
You can see that pricing power in Alphabet's latest 10-K. Cost-per-click (CPC) -- how much Alphabet charges advertisers every time someone clicks on an ad -- rose 15% over the course of 2021. And people clicked a lot more, too: Google's 2021 paid clicks rose 23% from 2020.
Image source: Getty Images.
Alphabet has another inflation-fighting ace up its sleeve. Rising energy costs are a big driver of inflation, but Alphabet blunts that impact with its heavy and growing reliance on renewable energy. By buying surplus renewable energy where it can to offset its fossil fuel energy use where it can't, Alphabet first reached carbon-neutral status in 2007. The company has also worked to make its data centers as energy-efficient as possible. Alphabet now says it buys more renewable energy than any company on Earth, with a goal to use only such energy sources by 2030.
2. Alphabet has a strong moat
Alphabet depends heavily on advertising, which made up 81% of its fiscal 2021 revenues and nearly all of its profits. But the company has built a strong moat to defend this vital business.
As one of the first companies to build out both a search and advertising platform, Google was able to create a strong brand ("Google" became a verb), amass a huge data advantage over competitors, and scale to a size against which very few companies can effectively compete.
But the company faces fierce competition from Amazon.com (AMZN +3.51%), which has begun placing ads next to product searches on its e-commerce site. According to WebFX, these Amazon ads are 2.7 times more effective and 2.8 times cheaper for advertisers over Google Search.
Recently, ad experts have argued that Amazon ads pose a serious threat to Google's moat. According to eMarketer, Google has a 28.6% share of the US digital ad market, compared to 11.6% for Amazon. However, Amazon is projected to gain 3% more market share by 2023, and Google is expected to lose 2.2% market share in the same period.
Alphabet is fighting back by trying to offer independent vendors a better place than Amazon to sell their goods. Alphabet recently partnered with Shopify (SHOP +6.13%) to help businesses hurt by Amazon's market dominance. Sellers using Shopify can now easily advertise their goods across Alphabet's popular search and other sites. From mid-2020, when the company stopped charging sellers to run those ads, to mid-2021, Alphabet reported an 80% jump in the merchants using its platform. Whatever short-term revenue the company loses by giving ads away for free, it's hoping to regain in the long term by wooing back users who might otherwise go straight to Amazon for search for things they want to buy.
3. Alphabet has less exposure to supply chain disruptions
Many experts argue that supply chain disruptions from COVID-19 are driving the current bout of inflation in areas like clothing, consumer goods, and food. Since Alphabet is primarily an advertising company, it has little exposure to many of the areas suffering from the recent truck driver shortage and other supply chain squeezes. Alphabet's business model avoids utilizing large delivery operations like Amazon or Shopify, exposing it to fewer costly logistical problems.
Alphabet is, however, affected by the ongoing chip shortage -- which affects the company's emerging hardware business, data center operations, and growth in cloud computing. But Alphabet's scale here helps blunt the worst of those impacts. Chipmakers have been prioritizing their biggest most profitable customers -- a list that includes Alphabet. So while it's feeling the chip crunch somewhat, it's in less pain than automakers and other industries.
Alphabet is a post-COVID economic recovery stock
Given Alphabet's high profitability and strong growth, it could make a strong pandemic recovery investment. Alphabet grew revenues 41% and net income almost 89% in fiscal 2021, on the back of US GDP growth of 5.7% in 2021. This compares to US GDP falling 2.3% in 2020, while Alphabet produced 13% revenue growth and 17% net income growth. Alphabet should do well as more businesses recover from the pandemic and contribute to overall economic growth.
