Faced with mounting economic uncertainty and the fast pace of interest rate hikes by the U.S. Federal Reserve to tamp down rising inflation, tech stocks had a year of reckoning in 2022. With company growth rates slowing as we head into 2023, many top tech names were sold off and left for dead.
Ignoring these stocks could be a mistake, though, as growth prospects are still robust for the decade ahead -- especially for AI and cloud computing. Three cheap AI stocks to consider before the end of the year are Alphabet (GOOGL 0.35%) (GOOG 0.37%), Meta Platforms (META 1.54%), and Pinterest (PINS 0.43%). Here's why.
1. Alphabet: Plenty of growth options built on fundamental internet functionality
Google parent Alphabet put up lackluster numbers in Q3 2022 (year-over-year revenue growth of just 6%, and operating profit margin contraction to 25% compared to 32% last year), but the company still has lots going for it. Search is a fundamental feature of the internet, used by billions worldwide every day. Alphabet continues to improve internet search functionality using AI all the time, installing high-end computing equipment in its global data centers to provide things like search recommendations to image-based search using Google Lens.
With vast stores of data on its hands, Alphabet has all sorts of growth levers to pull in the coming years. Its YouTube and Google Cloud businesses are just two of them, and Google Cloud, in particular, could be a huge driver of operating margin expansion as it continues to home in on break even (operating margin improved to negative 10% in Q3, up from negative 13% last year). The cloud is expected to be a double-digit percentage growth industry for years to come, so this remains a promising segment for Alphabet.
And yes, digital ads will also eventually make a comeback too -- once economic conditions start to improve.
In all, even after a pretty dismal showing for earnings last quarter, Alphabet stock trades for under 19 times trailing 12-month earnings (just under 20 times trailing 12-month free cash flow). That's incredibly cheap given this will still be a growth company in the decade ahead. Now still looks like an opportune time to buy for long-term-minded investors.
2. Meta Platforms: Don't count Zuckerberg out just yet
Meta CEO Mark Zuckerberg has faced all sorts of criticism for years from various factions, but it was the financial community that turned on the social media empire in 2022. While all the tech giants spent heavily on data center equipment and high-performance computing chips in the last year, Meta went a bit wild on this front. Capital expenditures more than doubled year-over-year in Q3 2022 to $9.4 billion, mostly for data center upgrades to support Zuckerberg's vision for the metaverse.
This heavy pace of spending was forecast to continue well into 2023 too. Digital ad activity is down this year due to economic conditions and Apple's operating system privacy changes -- which allows users to opt out of app activity tracking and, in turn, lowers the value of digital ads. Paired with the higher capex, the metaverse is torpedoing Meta's profit margins. Operating margin fell from 36% a year ago to 20% in Q3 of 2022.
But not all of this equipment is going strictly to a three-dimensional AI-enhanced virtual reality system. Zuckerberg and company have other things going on too. During the last earnings call, management talked up its messaging company WhatsApp, which apparently generated $1.5 billion in click-to-message ads that businesses have been running on Facebook. That represented about an 80% year-over-year increase for WhatsApp revenue.
Granted, WhatsApp sales are a drop in the bucket for the Meta empire, but the company is far from finished testing and iterating new ideas. For example, leading Latin American e-commerce giant MercadoLibre recently revealed it's in discussion with WhatsApp to handle digital payments for a new message-to-buy service. Features such as this also require data center investments, so there's no doubt more to the Meta "spending too much on the metaverse" story than meets the eye.
Shares of Meta currently trade for a paltry 11 times earnings (12 times free cash flow). If the company can reignite profitable growth, this is far too cheap to ignore.
3. Pinterest: Reviving a promising growth story using visual search
Pinterest stock has a long way to go before it fully recovers from its early pandemic boom-and-bust cycle. Share prices are down 75% from their all-time highs. But a recovery may already be underway.
In Q3 2022, Pinterest's user base in the U.S. and Canada grew (on a quarter-over-quarter basis) for the first time since early 2021. It's still too soon to tell, but perhaps new CEO Bill Ready's focus on making Pinterest an e-commerce tool is already paying off. Outside of a small advance in monthly average users, Q3 revenue was up 8% year over year, driven by higher value from advertising.
Of course, Pinterest still has a lot of work to do on profit margins. Much like Alphabet and Meta, it reported a big decrease in net income last quarter as it made new investments to increase the usefulness of its tools for marketers and increase engagement among users with more meaningful search results. Net income was negative $65.2 million (versus positive $94 million last year), and adjusted EBITDA fell 60% to $77.3 million.
Margins could continue to contract for a couple more quarters as Ready takes what he learned as the head of Google Commerce and applies it to Pinterest. But once this wave of expenses is finished, Pinterest's margins could rocket higher. In the meantime, the visual search site trades for 26 times trailing 12-month free cash flow (price-to-earnings isn't meaningful at the moment since net income just turned negative). If Pinterest can return to its early pandemic level of profitability and continue to gradually expand along the way, shares look like a great value right now.
