The current stock market is in no mood to tolerate any earnings misses, whether from a young upstart or a trillion-dollar company. Alphabet (GOOGL 0.55%), the parent of Google, found that out the hard way. It missed on analysts' top- and bottom-line estimates, and was punished with a more than 9% drop in its shares the next day.
Sure, Alphabet's earnings were lukewarm. But the market's sell-off of its shares, largely based on one quarter's performance and on top of the pullback over the past year, seems like an overreaction. Placing Alphabet's results in the context of the current economic environment, and looking at its future prospects, actually suggest that now may be an enticing time for long-term investors to add Alphabet shares.
Earnings were mixed, but not nearly as bad
Alphabet's overall revenue for the third quarter (ended Sept. 30) was up by only 6%, reaching $69.1 billion. Google services -- its largest segment at 88% of total revenue and consisting mostly of the ad business -- grew by just 2.5% to $61.4 billion. Both numbers were quite uninspiring. There wasn't much good news on the profitability front, either. The operating margin fell to 24.8% from 32.3%, and the net income margin contracted to 20.1% from 29% a year ago.
While the reported quarter's numbers don't look great, they also don't tell the full story when seen in isolation. Businesses are lowering their ad budgets with growing uncertainty around the economy as inflation stays high and interest rates continue climbing. Alphabet saw pullbacks in ad spending in Q3 from several sectors, including mortgage, lending, insurance, and crypto.
The strong U.S. dollar further dampened the company's numbers. Foreign exchange headwinds lowered year-over-year revenue growth by a notable 5%.
Finally, Alphabet was overcoming a really tough year-over-year comparison as sales had surged by a whopping 41% in Q3 2021. Considering all those factors, the company's modest growth is not a big surprise.
Image source: Getty Images.
CEO Sundar Pichai expects Alphabet to sharpen its focus on managing expenses with slower hiring in the coming quarters. That should help improve its margins in a tepid growth environment.
Even the big trillion-dollar stalwarts like Alphabet -- whose Google Search, YouTube, Maps, and Android products are so central to daily life -- aren't entirely immune to economic cycles. Looking at the big picture rather than placing too much emphasis on a few quarters can better validate the investing thesis.
The long-term story looks intact
The good news is that the current economic downturn isn't Alphabet's first rodeo. It successfully navigated major economic headwinds, including the 2001 dot-com crash and the 2008 global financial crisis. In many ways, Alphabet is in a dramatically better position to not only weather the ongoing macroeconomic storm but get even stronger.
Consider that the company's various products have over one billion users. Google Search, the engine that fuels Alphabet's growing product ecosystem and the ad revenue, has a 91% of the market share. Android, the mobile operating system, has a 71% market share.
Viewers across the globe watch over 700 million hours of YouTube content daily, and YouTube Shorts -- the company's TikTok competitor -- now has over 1.5 billion monthly users. And Alphabet hasn't even begun to monetize that service.
The essential nature of Alphabet's services in today's life makes it a top destination for advertisers, and that seems unlikely to change anytime soon. Alphabet has efficiently translated its product-driven moat into financial success with smart leadership and execution.
| Metrics | 2017 | 2018 | 2019 | 2020 | 2021 | CAGR |
|---|---|---|---|---|---|---|
| Revenue ($billion) | 111 | 137 | 162 | 183 | 258 | 23.5% |
| Free cash flow ($billion) | 24 | 23 | 31 | 43 | 67 | 29.4% |
Data source: Company earnings releases. CAGR = compound annual growth rate.
Alphabet's balance sheet is also plenty sound with over $116 billion in cash and equivalents on its balance sheet, and a nominal $15 billion in long-term debt. With that kine of liquidity, Alphabet has been able to invest over $123 billion in research and development and $108 billion in capital expenditures from 2017 through 2021 -- extending its lead in existing products and inventing new products.
Savvy investors realize that the sheer scale of its business, stickiness of its products, future potential ahead of it, and financial resilience make Alphabet one of the most attractive businesses. It's simply too hard for rivals to compete with Alphabet.
The valuation makes the decision even easier
Despite Alphabet's strengths, the current economic environment, the market's obsession over short-term results, and overall pessimism about tech stocks are driving a sell-off in Alphabet's shares.
But that sell-off means an opportunity for those willing to hold shares for the long term. On both a price-to-earnings and price-to-free cash flow basis, shares of Alphabet are trading toward the lower end of their 10-year values.
GOOGL PE Ratio data by YCharts
Near-term economic turbulence may cause Alphabet's shares to be volatile, but investing in this high-quality business at today's discounted price can produce exceptional returns in the long run.
