Alphabet's (GOOG -1.80%) (GOOGL -1.82%) stock price dropped 7% during after-hours trading on Tuesday, Oct. 25, following the release of its third-quarter report. The tech giant's revenue rose 6% year over year to $69.1 billion, but missed analysts' estimates by $1.6 billion. Its net income fell 27% to $13.9 billion, or $1.06 per share, which also missed the consensus forecast by $0.19.
Those headline numbers were disappointing, but does Alphabet's post-earnings pullback represent a good buying opportunity for long-term investors? Let's review its near-term challenges to decide.
Image source: Getty Images.
Why is Alphabet's growth cooling off?
Alphabet generated 79% of its revenue from Google's advertising business (which houses its search ads, YouTube, and advertising network) during the third quarter. It generated 10% of its revenue from Google's non-advertising businesses (including Google Play, YouTube subscriptions, and its hardware devices), and another 10% from Google Cloud, the world's third-largest cloud infrastructure platform. Here's how those three core businesses fared over the past three years.
|
Metric |
Q3 2022 |
Q2 2022 |
Q1 2022 |
2021 |
2020 |
|---|---|---|---|---|---|
|
Google Advertising Revenue Growth (YOY) |
3% |
12% |
22% |
43% |
9% |
|
Google Other Revenue Growth (YOY) |
2% |
(1%) |
5% |
29% |
28% |
|
Google Cloud Revenue Growth (YOY) |
38% |
36% |
44% |
47% |
46% |
|
Total Revenue Growth (YOY) |
6% |
21% |
23% |
41% |
13% |
Data source: Alphabet. YOY = Year over year.
Google's advertising business suffered a slowdown in 2020 as the pandemic throttled its ad sales. It recovered quickly throughout 2021 as those headwinds faded, but hit three major speed bumps throughout the first three quarters of 2022.
First, macro headwinds dampened the market's appetite for digital ads, and that slowdown was exacerbated by tough year-over-year comparisons to its post-pandemic recovery. Second, YouTube seemed to struggle against ByteDance's TikTok and other short video challengers. Those headwinds reduced YouTube's revenue by 2% year over year in the third quarter, which represented the segment's first contraction since Alphabet started disclosing its results separately in 2019.
Lastly, the rising dollar -- which will likely get stronger as interest rates rise -- significantly reduced Google's total ad revenue. On a constant currency basis, Alphabet's total revenue actually increased 11% year over year in the third quarter, but that still represented a slowdown from its 16% constant-currency revenue growth in the second quarter.
Google Cloud continues to grow, and it expanded significantly by acquiring the cybersecurity firm Mandiant in September. Unfortunately, the cloud segment's growth barely offset the deceleration of Google's other divisions in the third quarter, and it's still unprofitable. The slowing growth of Google's higher-margin advertising business, the ongoing expansion of its unprofitable cloud business, and the worsening currency headwinds have all reduced Alphabet's operating margins and net income this year.
|
Metric |
Q3 2022 |
Q2 2022 |
Q1 2022 |
2021 |
2020 |
|---|---|---|---|---|---|
|
Operating Margin |
25% |
28% |
30% |
31% |
23% |
|
Net Income Growth (YOY) |
(27%) |
(14%) |
(8%) |
89% |
17% |
Data source: Alphabet.
How long will this downturn last?
Alphabet didn't provide any exact guidance for the fourth quarter or the full year. But during the conference call, CFO Ruth Porat warned that the company would experience an "even larger headwind from foreign exchange" in the fourth quarter as its advertising business continues to struggle with "tough comps" to its "very strong revenue performance last year."
CEO Sundar Pichai said that as the company planned for 2023, it would "make important trade-offs where needed" and focus on "moderating operating expense growth." Therefore, Alphabet will likely cut costs and scrap money-losing projects until the macro situation improves. Analysts expect Alphabet's revenue to rise 12% for the full year, but for its earnings to decline 9%. But next year they expect its revenue and earnings to grow 11% and 15%, respectively, as its ad business stabilizes.
We should take those estimates with a grain of salt, but Alphabet has already weathered several major economic downturns since its founding (as Google) in 1998. During the call, Pichai reminded investors that throughout "Google's history, periods of dedicated focus have enabled us to emerge strongly and unleash new areas of computing innovation."
Based on those expectations, Alphabet's stock trades at just 17 times forward earnings -- while Amazon (AMZN -1.35%) and Microsoft (MSFT -1.96%) still trade at 50 and 24 times forward earnings, respectively. That lower multiple could limit Alphabet's downside potential and attract the attention of value-oriented investors.
Is Alphabet's stock still worth buying?
Most of Alphabet's recent problems are macroeconomic, and its business should recover quickly as those headwinds pass. That recovery probably won't happen for at least a few more quarters, but I believe it's still a great time to buy Alphabet as a long-term play on the digital advertising and cloud markets while it's being shunned by myopic investors.
