Shares of Alphabet (GOOG 0.66%) (GOOGL 0.49%) dipped 9% before 10 a.m. on Oct. 25 after the company posted its third-quarter earnings. Revenue rose 11%, beating forecasts by $980 million and returning to double-digit growth.
However, the jump in sales was overshadowed by a disappointing performance from its Google Cloud business, which didn't grow as much as expected. The company is heavily investing in the booming artificial intelligence (AI) market but seems to have fallen behind competitors Microsoft and Amazon.
Alphabet's stock has risen more than 130% in the last five years, with its dominance in digital advertising a compelling reason to invest in it. However, slowing cloud revenue could dampen its long-term prospects in AI.
So, before you fill up on shares of Alphabet, here is one green flag and one red flag for the company in 2023.
The green flag: Alphabet has made a solid recovery in ad revenue
Alphabet was hit particularly hard by macroeconomic headwinds in 2022, with its stock price tumbling 39% over the 12 months. Spikes in inflation and interest rates led many companies to slash budgets, with advertising being one of the first things to go. Over 80% of Alphabet's revenue comes from digital advertising, which meant its business was especially vulnerable to last year's economic downturn.
However, 2023 has seen a resurgence in Alphabet's ad segments. In the second quarter, Google Services revenue rose 5% year over year, with growth hitting close to 11% in the third quarter.
The increase is largely thanks to growth in Search and YouTube. These platforms garner billions of users per day and have allowed Alphabet to achieve a leading 25% market share in digital advertising.
Digital ad spending is projected to hit $680 billion this year. Meanwhile, Alphabet brands such as YouTube, Android, and the many services under Google provide the company with almost endless advertising opportunities. Its success in the industry has increased its annual revenue by 107% over the last five years, with operating income up 130%.
A large portion of Alphabet's business is still vulnerable to the economy, but its comeback this year illustrates why it's crucial to keep a long-term mindset and hold during uncertain times. The company's dominance in advertising is likely to continue offering significant gains to patient investors.
The red flag: Cloud revenue disappointed in the recent quarter
AI has blown up this year, with an increasing number of businesses and consumers seeking ways to use the technology to boost efficiency. As a result, cloud companies are rushing to expand their AI services and profit from that market's projected compound annual growth rate of 37% through 2030. Alphabet has joined in, adding new generative AI tools to Google Cloud and gradually integrating the technology across its product lineup.
Google Cloud holds a 11% market share in cloud computing, making it the world's third-largest cloud platform. However, it's significantly behind the top two, Amazon Web Services and Microsoft's Azure. The AI market is expanding quickly, and Alphabet is finding it challenging to make headway through its cloud business.
In the third quarter, Google Cloud revenue came to $8.4 billion, falling short of analyst expectations by about $230 million. In the same quarter, Microsoft's Azure revenue climbed 29% year over year, beating forecasts of 26%.
Microsoft got a head start in AI with its 49% stake in ChatGPT developer OpenAI, which made it one of the first companies to introduce AI upgrades to its services. As a result, Alphabet's prospects in the cloud market are weakening, which could threaten its earnings potential in AI.
Alphabet remains an attractive tech stock with its dominance in digital ads and the potency of Google Search and YouTube among consumers. Meanwhile, its price-to-earnings ratio of 24 has made it one of the best bargains in tech.
However, its future in AI is uncertain. So if you're looking specifically for an AI stock, it might be best to consider alternatives such as Microsoft.
