Alphabet (GOOG 0.37%) has some of the premier advertising space on the internet with its Google and YouTube platforms. However, the advertising business isn't always great, as clients' budgets ebb and flow with the economy.
We're currently experiencing the downside of the advertising market, which is why Alphabet's stock has had a poor performance over the last 12 months, down 28%. But I think now presents a great buying opportunity, and there are two great reasons you should consider picking up some shares.
1. Google Cloud is providing some balance
While advertising makes up much of Alphabet's revenue, the Google Cloud computing division is becoming a more significant part of the picture. Advertising revenue fell 3.6% year over year, while Google Cloud's sales rose 32%. Although Google Cloud isn't profitable yet, it's steadily improving.
| Quarter | Google Cloud Operating Margin |
|---|---|
| Q1 2022 | (16%) |
| Q2 2022 | (13.7%) |
| Q3 2022 | (10.2%) |
| Q4 2022 | (6.3%) |
Data source: Alphabet. Table by author.
From that trajectory, Google Cloud might be profitable sometime in 2023, which backs up management's comments in the quarterly earnings call.
Cloud computing is a massive market opportunity that some estimates peg will reach $1.6 trillion by 2030, so it's critical Alphabet continues growing this segment. Additionally, as Google Cloud becomes a larger part of Alphabet's revenue stream, it makes the business more steady in times of economic uncertainty, as it operates off of subscription, not discretionary-like advertising spending.
Clients can't just choose not to utilize cloud computing resources; once they're on it, switching or reducing usage is difficult.
This huge opportunity for Alphabet remains one of the top reasons to own the stock.
2. Cost-saving measures will help
Although Google Cloud is exciting, advertising still pays the bills at the end of the day. Google services (which includes ads and its "other" division) generated $21.1 billion in operating profits, down 27% from the prior year's total. Alphabet's revenue decline didn't cause all that; its massive hiring spree did.
It hired nearly 34,000 people throughout 2022, although it laid off 12,000 employees in January. That's a significant increase for not a lot of results, but Alphabet's management insists that most roles it hired for were engineering and technical talent, which should pay off in the future.
Alphabet will take a severance charge of about $2.1 billion at the midpoint (an astounding $175,000 per laid-off employee) in Q1, but these cost-saving measures should start impacting results later in the year and take full effect in 2024.
2023 capital expenditures will also be in line with 2022's values, with a greater focus on "technical infrastructure" and a decline in "office facilities."
All of these cost savings and investments will have a significant effect when the advertising spending spigot is turned back on. As economic downturn fears decrease, client spending should return, driving a substantial increase in profits.
When that happens, Alphabet's historically low valuation will become even cheaper.
GOOG Price to Free Cash Flow data by YCharts
That catalyst will lead to a massive stock turnaround, although I can't predict when exactly that is coming. Investors should consider taking a position now, before the stock runs up, in anticipation of this turnaround. With the stock up 13% year to date, the rebound may have already begun, but it's far from over.
