Alphabet's (GOOG 0.59%) (GOOGL 0.51%) stock price dropped 6% during after-hours trading on Oct. 24 following its third-quarter report. The tech giant's revenue rose 11% year over year to $76.7 billion, surpassing analysts' estimates by nearly $1 billion, as its EPS rose 46% to $1.55 and cleared the consensus forecast by a dime.
Those growth rates were robust, so does Alphabet's post-earnings dip represent a buying opportunity? Let's review three reasons to buy the stock -- along with three reasons to sell it -- to see if it's a contrarian buy or a falling knife.
Image source: Getty Images.
The key numbers
Alphabet generated 78% of its revenue from Google's advertising business (including its search, network, and YouTube ads) in the third quarter.
Google's "other" non-advertising businesses (including its subscriptions, a la carte services, and hardware devices) generated another 11% of its revenue. The remaining 11% primarily came from Google Cloud, the third-largest cloud infrastructure platform in the world. Here's how those three core businesses fared over the past year.
|
Metric |
Q3 2022 |
Q4 2022 |
Q1 2023 |
Q2 2023 |
Q3 2023 |
|---|---|---|---|---|---|
|
Google Advertising Revenue Growth (YOY) |
3% |
(4%) |
0% |
3% |
9% |
|
Google Other Revenue Growth (YOY) |
2% |
8% |
9% |
24% |
21% |
|
Google Cloud Revenue Growth (YOY) |
38% |
32% |
28% |
28% |
22% |
|
Total Revenue Growth (YOY) |
6% |
1% |
3% |
7% |
11% |
Data source: Alphabet. YOY = Year over year.
The three reasons to buy Alphabet
The bulls still admire Alphabet because its advertising business is recovering, its subscriptions are growing, and its operating margins are expanding.
Google's year-over-year advertising revenue growth accelerated for the third consecutive quarter. That recovery was fueled by its rising ad sales to retail customers on its search engine as well as its higher sales of brand and direct response ads on YouTube. The growth of those two ad platforms offset its declining sales of network ads.
Google's "other" revenue also rose more than 20% for the second consecutive quarter as YouTube Premium and YouTube Music gained more paid subscribers. Google's new Pixel 8 phones and Pixel Watch 2, which launched earlier this month, could generate additional tailwinds for this segment in the fourth quarter.
As Google's revenue growth accelerated again, its operating margin expanded three percentage points year over year to 28% in the third quarter. That expansion was mainly driven by a three-percentage-point improvement in Google Services' operating margin as well as Google Cloud's third consecutive quarter of positive operating margins.
The three reasons to sell Alphabet
The bulls believe Alphabet will continue to struggle as its cloud growth cools off, it faces existential challenges in the artificial intelligence (AI) market, and regulators tighten the screws on its advertising business.
The growth of Google's Cloud business decelerated significantly in the third quarter as the macro headwinds drove companies to rein in their software spending. Its 22% growth broadly missed the consensus forecast for 26% growth and sparked fresh concerns that it could be falling behind its two larger rivals, Amazon Web Services (AWS) and Microsoft Azure, in the cutthroat cloud race.
Alphabet mentioned AI about a dozen times during its conference call as it highlighted AI upgrades for its search engine, visual search tools, and language models. But over the long run, generative AI platforms like OpenAI's ChatGPT could still chip away at Google's dominance of the search market with faster and more succinct responses.
As for the regulatory challenges, the U.S. Department of Justice (DOJ) and a coalition of state attorneys general launched an antitrust lawsuit against Alphabet last month. It also faces unresolved antitrust charges in the European Union. These headwinds could disrupt Alphabet's recovery and narrow its competitive moat.
Is it a contrarian buy or a falling knife?
Analysts expect Alphabet's revenue and earnings to grow 8% and 24%, respectively, in 2023 as its advertising business continues to recover. For 2024, they expect its revenue and earnings to rise another 11% and 19%, respectively. Those are robust growth rates for a stock that trades at just 21 times forward earnings.
As an Alphabet investor, I believe the accelerating growth of its advertising business matters more than the slowing growth of Google Cloud -- which should stabilize as the macro environment improves. Its AI and regulatory challenges won't end anytime soon, but most of Google's competitors -- including Amazon and Microsoft -- face similar challenges. In short, patient investors should tune out the noise and still buy Alphabet as a long-term play.
