One of the five FAANG stocks that has led the market over the last decade, Alphabet (GOOG -4.50%) (GOOGL -4.44%) is a household name, thanks to products like Google Search and YouTube. However, the stock has pulled back during the broader market sell-off this year as investors have grown concerned about how a recession and a slowdown in digital advertising sales could impact the company.
Has this year's 30% or so decline created a good opportunity for investors to buy shares of Alphabet, or should they stay away?
The bull case: A great company at a great price
Jeremy Bowman: A buy thesis doesn't have to be complicated, and Alphabet is just the kind of stock you don't want to overthink.
The company owns one of the most powerful businesses in the world: Google Search. It's an essential internet utility across much of the world. "To Google" has long since become a verb, showing its powerful mindshare, and it has a near monopoly in search with a roughly 90% market share outside of China.
Search is also a profit machine for Alphabet, and one that requires little investment. It's the linchpin in the Google Services segment, which generated $22.8 billion in operating income in the second quarter -- with an operating margin of 36.2%. The search business itself was likely even more profitable.
Alphabet's other segments outside of services are actually losing money: Both Google Cloud and its "Other Bets" businesses operate at losses. However, that seems more like an opportunity, as Google Cloud should eventually grow into profitability, and the Other Bets segment could use more cost discipline.
Alphabet stock is on sale now, down roughly a third from its peak a year ago, and trades at a price-to-earnings ratio of just 18. If you back out the company's cash hoard of $124 billion, that ratio is closer to 16, cheaper than the S&P 500's 19.3. Additionally, the company is aggressively buying back stock, with $28.5 billion in repurchases in the first half of the year. It makes sense for it to be aggressive with buybacks, considering the now-lower share price.
Alphabet may not have a license to print money, but it has the next closest thing: a virtual monopoly in a massive market. It also has room for growth, wide profit margins, and a cheap valuation. Now would be an excellent time to buy this stock.
The bull case: Watch out for macroeconomic pressures and regulatory risks
Keith Noonan: Alphabet is a strong company, but there are negative catalysts ahead that could cause the stock to underperform, and even bullish investors should weigh the risks carefully.
While the S&P 500 has fallen by roughly 23% this year, Alphabet's share price is down by about 30%, and it could continue to lag the benchmark index if conditions in the broader market remain turbulent.
Even though Alphabet doesn't look exorbitantly valued at roughly 20 times this year's expected earnings, it's still a growth-dependent tech stock. Inflation remains at levels not seen in 40 years, and tech stocks could continue to experience outsized sell-offs if the Federal Reserve keeps hiking interest rates rapidly in its effort to get that situation under control. Alphabet's core business could also weaken in the face of other macroeconomic headwinds.
Last quarter, digital advertising accounted for roughly 81% of Alphabet's overall revenue. While the digital ad space looks poised for growth over the long term, it's possible that a prolonged recession or other macroeconomic pressures will soften demand in the nearer term. Businesses often cut down on marketing and advertising budgets during recessionary periods and when the economic outlook is uncertain, and a challenging macro backdrop could mean weaker sales and earnings growth for Alphabet.
In addition to the risk of a business slowdown or pressures shaping the market at large, developments on the regulatory front could depress Alphabet's valuation. The company enjoys incredibly strong positions in digital advertising and mobile, but its leadership in these categories has also drawn government scrutiny, and the company faces antitrust suits in the U.S. and Europe. Thus far, the tech giant has an impressive track record when it comes to navigating these types of challenges, but unfavorable antitrust judgments or other shifts in the regulatory climate could have substantial negative impacts on its share price.
Alphabet is a great company overall, but investors should understand there are still risk factors that could derail the stock.