My Top FAANG Stock to Buy for the Second Half of 2023 (and Beyond)

You don't have to be Einstein to understand relativity. In this case, I'm talking about the fact that, although this is a relatively "bad" year (advertising spending is under pressure from a weakening economy) for Google's parent Alphabet (GOOG 9.96%) (GOOGL 10.22%), the stock still represents excellent value, and offers exciting long-term growth prospects.

Not least because management is taking action to improve its underlying offerings by using artificial intelligence (AI), investing in Google Cloud, and improving its YouTube and search. Here's why Alphabet is an attractive stock. 

The investment case for Alphabet

Continuing the relativity theme, Alphabet is not perfect, but the pros significantly outweigh the cons on balance. Any business that relies on advertising revenue will experience the cyclicality of ups and downs in the economy. That much is apparent in a breakout of Alphabet's revenue in the first quarter. 

As the table shows, Google Advertising revenue declined year over year in the first quarter, with the Google Network component (AdSense, Google Ad Manager, etc.) hit particularly hard by a reduction in ad spending.

Data source: Alphabet presentations. *Total figures do not add up due to a) the exclusion of Other Bets and hedging, which together reduced revenue by $406 million, and b) rounding effects.

That's the bad news from the quarter, but there's plenty of positive news, as I'll outline below with five key points. 

Cyclicality and YouTube's underlying improvement

First, there's little Alphabet can do about the broader economy. Still, Google Services (advertising-focused businesses) grew in challenging market conditions, and the total company revenue grew. Not only is the economy is slowing, but Alphabet is also coming up against different comparisons from bumper years when pandemic stay-at-home measures imposed on the populace led to a surge in online activity. 

If history is a guide, the economy will turn up again, which will boost Google Services revenue in due course. 

Second, although YouTube revenue declined in the quarter, there are strong signs of stabilization. For example, the chart below shows the usual sequential decline in YouTube ad revenue from the fourth quarter (which includes Thanksgiving and Christmas) and the first quarter. The decline in the latest first quarter is slightly better than in the last pre-COVID "normal" decline from the fourth quarter of 2018 to the first quarter of 2019.

Data source: Alphabet presentations.  

In addition, note that Google Other revenue rose $602 million year over year, driven by "ongoing significant subscriber growth in YouTube TV and YouTube Music Premium," chief financial officer Ruth Porat said on the earnings call. Growth in YouTube subscribers should enhance opportunities to increase revenue from that subscriber base. 

Google Cloud and artificial intelligence

Third, Google Cloud's revenue increased by 28% year over year, and the business delivered its first quarter of profitability for the company, with $191 million in income. That might not sound like a lot in the scheme of things, but it still represents a nearly $900 million improvement on the first quarter of 2022, and it more than offset the $236 million decline in operating income at Google Services.

As such, investors can expect significant future growth in Cloud income and cash flow, since it's a business with substantial recurring revenue. 

Fourth, management pointed to tangible improvements in its offerings due to its AI investments. For example, chief business officer Philipp Schindler said that by using AI in its Performance Max (a service intended to improve ad campaigns), advertisers on average achieved 18% better conversions for the same cost per action. That figure, Schindler said, was up from 13% "in just 14 months, thanks to advances in the AI underlying bidding, creatives, search query matching and new formats like YouTube Shorts."

It's an early indication of the power of Alphabet's AI investments.

A great value stock

Last, in a "bad" year for the company, the Wall Street consensus is for Alphabet to generate $116 billion in earnings before interest, taxation, depreciation, and amortization (EBITDA) and $70 billion in free cash flow (FCF), and end the year with $123 billion in net cash. 

Based on the current market price, these figures put Alphabet on an 11.7 multiple of enterprise value (market cap plus net debt) to EBITDA, and a price-to-FCF multiple of 21 times FCF. Despite the recent rise, those valuations are attractive for a company in a challenging year with plenty of long-term growth prospects.