The Nasdaq-100 index is trading firmly in bear market territory with a year-to-date loss of 30%, so the financial results of the largest technology companies are extremely important to watch at the moment.
Earnings season for the quarter ended Sept. 30 is now underway, and Google's trillion-dollar parent, Alphabet (GOOGL 0.55%) (GOOG 0.74%), released its results last week. It revealed a clear slowdown in the most fundamental parts of its business, but the fast-growing Google Cloud was a bright spot once again.
Investors have sent Alphabet stock down 33% in the last 12 months, but here's why they should look beyond the company's recent struggles and focus on the long term -- there are no shortage of positives.
Image source: Getty Images.
The long and the shorts of YouTube
YouTube is the world's largest online video platform, and in September, it actually led TV streaming viewership in the U.S. for the first time ever. But YouTube generates revenue through advertising, and since the global economy is currently grappling with a slowdown from high inflation and rising interest rates, businesses have trimmed their marketing budgets.
As a result, YouTube's revenue shrank by 1.8% year over year in the third quarter. But it's not alone in this struggle, because social media companies Meta Platforms and Snap also reported weaker-than-expected results for the period.
Here's the thing, though. YouTube released Shorts two years ago to compete with ByteDance's TikTok, the short-form video king. Shorts is already succeeding having amassed 1.5 billion monthly active users with 30 billion daily views on average, placing it on par with its fierce new rival based on publicly available data.
Shorts is accounting for more of users' time spent on YouTube, but short-form content monetizes at a lower rate than longer videos, which is creating a revenue headwind for Alphabet. Put simply, users prefer Shorts, but the format makes less money for the company. Alphabet is exploring new strategies to fix that problem, including a revenue-sharing arrangement with creators from 2023 that will encourage more premium content (which, in turn, is more attractive for advertisers).
In addition, social shopping could be a major revenue opportunity for YouTube overall. Creators will be able to tag products in their videos, which will enable viewers to make purchases while they're watching content. To summarize, investors shouldn't expect YouTube's recent financial slowdown to last forever.
Google Cloud shines amid slowing Google Search revenue
Google remains Alphabet's flagship brand and Search is still its core driver of advertising revenue. But for that reason, it's suffering from similar issues to YouTube on account of the broader economic slowdown.
Search generated $39.5 billion in revenue during Q3, a modest increase of 4.2% year over year. Alphabet's CFO, Ruth Porat, remarked that the slow growth rate was partly attributable to an incredibly strong comparable (last year's result). That's true -- in Q3 2021, Search generated a whopping 44% growth and that would've been very difficult to replicate amid the economic weakness at the moment.
But one area of Alphabet's business that outperformed was Google Cloud, with sales soaring by 37%. It marked an acceleration from its second-quarter growth rate of 35%, and while it only made up about one-tenth of Alphabet's total Q3 revenue, the cloud industry is on track to be a $1.5 trillion opportunity by 2030, so it's an important area of focus for the company.
As more businesses migrate their operations online, they will require more of the services provided by Google Cloud, including data storage and analysis, software development tools, cybersecurity, plus a range of artificial intelligence and machine learning applications. Thus, Google Cloud will become increasingly critical to Alphabet's growth over time.
Why Alphabet stock is a buy right now
Alphabet stock fell by more than 9% the day after the company released its Q3 earnings report, and it has now lost 33% of its value in the last 12 months.
Alphabet has posted earnings per share of $5.03 over the last four quarters, placing its stock at a price-to-earnings ratio of just 18.7. That's a 19% discount to the Nasdaq-100 index, which trades at a ratio of 23. It implies Alphabet stock will have to rise by approximately 23% just to trade in line with its peers in the technology sector.
The caveat is that Alphabet's earnings have shrunk in every quarter of 2022 so far (year over year), so investors have crushed the stock's valuation based on the premise that the company will grow much more slowly going forward. But that's no certainty. Alphabet has a suite of incredible businesses -- Google consistently maintains a market share above 90% in the search industry, Google Cloud is growing rapidly, and YouTube has an incredible opportunity in its new Shorts format for both advertising and social shopping.
This year has been tough, but history shows that economic weakness doesn't last forever. When the economy bounces back, investors might be glad they bought Alphabet stock right here on the dip.
