Looking back on 2022, it will be tempting for investors to focus solely on the agonizing downturn inflicted on the major U.S. stock market indexes. The bear market has mauled each one, but the worst performer -- by a country mile -- is the Nasdaq Composite. The tech-centric index began its descent more than a year ago and is still down by nearly 35% from its late 2021 high.
While the rout has sent many running for the exits, seasoned investors know this is part of the cost of admission, and game-changing wealth can still be made over time. Why, you ask? Because each and every bear market in history has given way to a bull market, which historically runs much farther for much longer. Furthermore, these occasional market nosedives let investors buy businesses with proven track records at unbelievably low prices.
One such bear-market bargain hiding in plain sight is Alphabet (GOOGL -1.23%) (GOOG -1.10%). Like many technology companies, the current headwinds have pounded the stock. However, those with the foresight to step back and take a broader view will discover a stock they should be buying like there's no tomorrow.
Image source: Getty Images.
Call out the search party
This year hasn't been a pleasant one for Alphabet shareholders, and it's easy to understand why some investors have had their faith shaken. In the third quarter, revenue of $69 billion grew just 6% year over year, though it would have increased by 11% if not for exchange rate headwinds. Perhaps more distressing was the bottom line, as its diluted earnings per share (EPS) of $1.06 tumbled 24%.
Glass-half-full investors will note that the company generated free cash flow of more than $16 billion, even in the midst of the worst downturn in more than a decade.
The sales slump was driven by weakening demand for its industry-leading digital advertising services, as Google's advertising revenue increased by just 2%. Advertising is historically among the first budget items to be slashed in times of uncertainty, as it can easily be dialed back or increased without serious consequences.
Fortunately, Google Cloud fared much better, as revenue grew 38% year over year, fueled by the ongoing digital transformation and the secular shift toward cloud computing.
Still, given the appalling top- and bottom-line performance, it's no wonder investors were distressed at the results, which drove the stock down by 9% on the day following its report. It now sits 41% below last year's high.
However, investors might miss the big picture by focusing too closely on one quarter's results.
A snapshot
Turning back the clock by just one year should help provide investors with some much-needed perspective. In the 2021 third quarter, Alphabet reported revenue of $65.1 billion, up 41% year over year. At the same time, diluted earnings per share of $27.99 grew 71%. Hardly the performance of a company in peril.
This look back into the past is instructional because it clarifies that Alphabet, like many technology stalwarts, is feeling the temporary pinch resulting from the downturn. But, more importantly, history shows that once the economic headwinds diminish, industry-leading businesses -- like Alphabet -- will not only recover from recent losses but also reach new heights.
More where that came from
If you believe Alphabet's growth is behind it, you've got another thing coming.
Marketers might temporarily reduce or even suspend their ad budgets, but that's a stopgap measure at best. It won't be long before the advertising dollars begin flowing once again. When they do, Alphabet will be there to answer the call.
Google search is the funnel that will drive future growth, controlling a dominant 92% of the worldwide market. This fuels Google's industry-leading digital advertising business -- another area it dominates -- commanding roughly 30% of worldwide digital ad spending, according to Digiday.
Then there's Google Cloud, which has ascended to the third-largest worldwide infrastructure service provider, trailing Amazon Web Services (AWS) and Microsoft Azure. Google continues to gain market share, however, and is the fastest-growing of the three. Google's cloud computing revenue surged 48% year over year in the third quarter, while Azure and AWS rose 35% and 27%, respectively, according to Canalys.
The common thread here is resilient businesses with large opportunities, temporarily bogged down by gale-force macroeconomic headwinds. This all suggests a stunning recovery for Alphabet stock once the economy bounces back.
Let's talk about price
Given Alphabet's undisputed leadership in both search and digital advertising, and its strong position in cloud computing, the stock is selling for a song, at roughly 4 times next year's sales, an extremely reasonable valuation given its history of strong growth and continuing prospects. It's also near the stock's cheapest valuation ever.
The preponderance of the evidence suggests that the current economy is temporarily weighing on Alphabet's performance.
"This too shall pass," as the old saying goes. When it does, buying Alphabet stock now will seem like a genius move.
