Since its initial public offering in 2004, shares in Google -- now Alphabet (GOOGL 0.66%) (GOOG 0.56%) -- have enjoyed exponential growth. But the 2022 bear market was particularly challenging for the company, leaving its stock price down 26% over the past 12 months. Still, this innovative tech giant can overcome near-term challenges and regain its mojo. Let's explore how.
What went wrong recently?
Like many technology companies, Alphabet's business surged at the height of the coronavirus pandemic, when stay-at-home shopping and government stimulus checks led to an economic boom. Its 2021, revenue soared 41% to $257.6 billion. And the company was a profit machine, generating an operating income of $78.7 billion -- among the highest in the world.
But like those of many tech companies, Alphabet's fortunes quickly reversed in 2022. For starters, the Federal Reserve embarked on its fastest rate-hike cycle in history. That hurt growth-stock valuations by reducing the discounted future value of their earnings, and corresponded with deteriorating fundamentals.
Revenue growth decelerated to 10%, while operating margins declined from 31% to 26% as challenges like inflation and rising rates battered the advertising industry. In uncertain economic times, enterprises are likely to cut back on their ad spending to save money, which means fewer customers for Alphabet's search business.
But this isn't the new normal for Alphabet. As a cyclical company, its performance will ebb and flow, depending on macroeconomic conditions. Most importantly, management is taking some key steps to make sure it can bounce back stronger than ever when the macro outlook improves.
1. Alphabet is trimming the fat
Over-expansion is part of the reason why Alphabet's margins have weakened. During the pandemic, the company hired too many staff in anticipation of growth that didn't materialize. And now it's cutting back. In January, CEO Sundar Pichai announced plans to lay off 12,000 workers.
This month, management also announced sweeping employee service cuts, trimming benefits such as fitness classes, massages, and snacks, which were provided to workers free of charge. According to activist investor TCI Fund Management, the median salary at Alphabet is nearly $300,000, which could put the cost savings of the layoffs alone at a whopping $3.6 billion.
Image source: Getty Images.
Belt-tightening is happening all over the technology sector, so in the future, companies like Alphabet may no longer be under as much financial pressure to attract the best talent. For investors, this could mean better margins and less stock-based compensation, a non-cash charge which dilutes their claim on future earnings and cash flow.
2. AI is more of an opportunity than a threat
Alphabet's long-term prospects depend on more than just cost-cutting. As the owner of the two most visited websites on the planet, Google and YouTube, Alphabet has gathered a treasure trove of data that rivals can only dream to have.
The company is also a top contender in the artificial intelligence (AI) arms race. Some industry watchers believe that generative AI could kill the market for Alphabet's search business, Google. But while Al advancements could certainly increase competition for Alphabet, they present more of an opportunity than a challenge.
With a forward price-to-earnings (P/E) multiple of 17, Alphabet shares are a relatively cheap way to bet on this potentially transformational trend.
