Like much of the tech sector, Alphabet (GOOG 0.56%) (GOOGL 0.42%) has significantly underperformed the broad market this year.
With just two weeks left to go in 2022, shares of the search giant are down 37% year-to-date as the company's growth has slowed, profits have fallen, and fears of a recession have mounted.
Despite those challenges, Alphabet looks well-prepared for a comeback in 2023. Here are three reasons why.
NASDAQ: GOOGL
Key Data Points
1. Alphabet's profitability should improve
Like other Silicon Valley companies, Alphabet has something of a reputation for wasting money. Google's core ad business makes money hand over fist, and the company can afford to spend on lavish perks, moonshot projects that it has had trouble monetizing, and aggressive hiring, even as the business is slowing. Headcount, for example, has increased 24% over the past year to 187,000 even as revenue growth slowed to just 6% in the third quarter.
However, management is well aware of investor concerns about the company's spending, and told investors on the earnings call that hiring would slow down in the fourth quarter and into 2023. CFO Ruth Porat said that in the fourth quarter the company expected to hire less than half of the 12,765 people it added in the third quarter. In 2023, Porat said the company's actions to slow hiring would become more apparent.
Since employees make up a significant percentage of Alphabet's expenses, the slowdown in hiring should help lift profit margins next year, as well as address a main investor concern.
2. The advertising business will recover
Advertising is a cyclical industry, and it's often one of the first expenses that businesses cut when they sense a slowdown in the economy. With digital ads, it's especially easy to ramp spending up or down according to demand and budget.
Alphabet has experienced this snapback effect in advertising twice before, during the 2008-09 financial crisis and during the initial stages of the pandemic. Both times, advertising demand recovered quickly. In 2009 revenue growth slowed to just low-single digits before recovering to 25% the next year, and during the lockdown Alphabet's revenue actually went negative for a quarter before surging the following year.
We don't know if there will be a recession or how long it will last, but we do know that advertising demand will recover -- and Alphabet's ad platforms, like Google search and YouTube, are essential customer acquisition channels for thousands of brands.
Alphabet isn't losing market share. It's just experiencing the same macro headwinds as the rest of the industry, and those will eventually fade. While that might not happen in 2023, it's a good bet that the recovery will begin next year.
3. Alphabet stock looks cheap
Alphabet is one of the most dominant businesses on the planet, and it has routinely posted above-average growth. However, the stock currently trades at a price-to-earnings (P/E) ratio of just 18.4, less than the S&P 500 at 20.2.
If you back out Alphabet's $116 billion in cash and equivalents, its P/E ratio is closer to 16, which seems undervalued compared to the broad market, especially since revenue growth and profitability should improve.
Alphabet has also been steadily buying back shares, repurchasing $44 billion in stock through the first three quarters of the year, reducing shares outstanding by 3% over the past year. With the stock price down significantly from a year ago, the company could be enticed to accelerate the buybacks, especially with more than $100 billion in cash and equivalents on the balance sheet.
As the company looks to moderate its expenses, it could also choose to accelerate share buybacks with that extra cash, especially if the stock remains down.
Going into 2023, Alphabet trades at a discount to the S&P 500, the company is taking steps to control costs, and it's likely to benefit from a rebound in advertising demand.
Taking all of those factors into account, Alphabet's stock looks excellently positioned to beat the market next year.
