YouTube owner Alphabet (GOOG 1.34%) (GOOGL 1.32%) has been a great investment over the last decade. Even after the recent sell-off that has brought the stock down 31% from its all-time high, a $100 investment at this time in 2013 would be worth over $500 now. That's an above-average return, but can long-term investors expect similar gains over the next 10 years?
With annual revenue approaching $300 billion, the Google parent is not a spring chicken anymore. In the first quarter, revenue rose just 3% year over year, down from 23% in the year-ago period. The slowing growth reflects weakness in the digital advertising market, which is how Alphabet monetizes users in search and YouTube. Advertising made up 78% of the company's first-quarter revenue.
You can start to see why the shares have fallen over the last year. When the underlying business isn't offering enough growth to support a growth stock's high valuation, it's a recipe for disappointing returns.
However, the ad market won't always be this weak. In the recent quarterly update, management pointed to resilience in search, its largest business. However, Alphabet faces increasing competition from Microsoft's Bing. Let's take a closer look to see if investors should buy the stock now.
Google's lead in search is narrowing
Alphabet generates revenue from cloud services and other businesses, but advertising pays the bills. The company's main sources of advertising revenue are search, YouTube, and its network of partner sites. Specifically, revenue from search made up 58% of the business last quarter.
| Segment | Q1 2023 | YOY Change |
|---|---|---|
| Google Search and other | $40.4 billion | 2% |
| YouTube ads | $6.7 billion | (3%) |
| Google Network | $7.5 billion | (8%) |
| Google Cloud | $7.4 billion | 28% |
| Other revenue | $7.8 billion | 3% |
| Total revenue | $69.8 billion | 3% |
Data source: Alphabet. YOY = year-over-year.
The meager 2% year-over-year growth in Google Search revenue looks particularly weak next to Microsoft's latest results. The software giant recently relaunched Bing, along with its Edge web browser, with new functionality powered by artificial intelligence (AI). In Microsoft's most recent quarter, revenue from search advertising increased 10% year over year, which shows Bing gaining market share against Google.
In fact, Google has been losing share in desktop search for many years. Bing's share has improved from 4.6% in 2015 to 8.2% in 2022, while Google's has fallen from 88% to 85%. It's not much of a loss, but the long-term sustained decline in Google's market share in its largest business reflects weakness in the company's competitive moat.
Investors shouldn't expect Alphabet to sit idle while another competitor chips away at its lead. Yes, Microsoft has a mountain of cash to invest in new opportunities, but so does Alphabet.
Over the last year, Alphabet generated $60 billion in free cash flow compared to Microsoft's $57 billion. The company recently unveiled new advancements in artificial intelligence (AI) that allow its search engine to understand what users are asking. For example, Alphabet said it wants search to be able to answer questions like which music instrument is easier to learn and how much practice is required, etc.
Alphabet centered its business around AI six years ago. It's the growth engine that drives the entire company, including Google Cloud, YouTube video recommendations, and advertising placement. Its deep pockets of cash resources means that it will fight back aggressively against competitors. I wouldn't be too concerned about its losses in market share at this point.
Should you buy the stock?
CEO Sundar Pichai compared the opportunity in AI to the company's transition from a desktop-centered business to mobile computing over a decade ago. This successful transition helped drive sustained growth over the last decade and fueled stellar returns for shareholders.
When you think about it, the accelerating adoption of AI is steering right into the sweet spot of Google's strength. I would expect the company's apps and services, including Gmail, to grow even more relevant for billions of users from here. AI will only tighten the bond that people have with Google and YouTube, and this is why I believe the stock is a buy at these lower share prices.
