Alphabet (GOOGL 0.14%) (GOOG 0.01%) stock has been a big winner in 2023, rising 50% so far this year. This gain crushes the broader Nasdaq Composite index. Investors seem to be looking to the biggest and most successful companies as safe havens right now, with the digital ad and cloud computing giant rising alongside other "Magnificent Seven" stocks.
Yes, there's good news to be excited about now with this FAANG business. However, there's also a red flag when it comes to Alphabet. Here's what investors need to know.
Green flag: Improving financials
Rapidly rising interest rates and high levels of inflation in 2022 affected digital advertising, an industry in which Alphabet is a leader. In anticipation of a possible recession, marketing executives will be quick to pare back spending. This is what happened last year, leading to decelerating revenue growth for Alphabet, which generates the vast majority of sales from digital ads.
But in 2023, things have been improving. Revenue growth has accelerated on a year-over-year basis in three straight quarters as the industry picks up steam. Sales increased 11% in the third quarter (ended Sept. 30), the first double-digit gain since the second quarter of 2022. Management called out the growth within the retail vertical as a key source of advertising strength during the quarter.
This faster top-line growth has happened at the same time that Alphabet is reaping the rewards of its cost-cutting measures. Operating expenses in the quarter totaled $22.1 billion, which was up 6% on a year-over-year basis. The company has been stricter with its spending, especially on employee services. And in January of this year, Alphabet announced layoffs for 12,000 of its employees, a move that many other tech enterprises made.
Diluted earnings per share totaled $1.55 in the latest quarter, up 46% compared to Q3 2022. This was a faster pace of change than the top line, thanks to an expanding operating margin. Shareholders should be extremely encouraged by the direction that Alphabet's financials are heading in.
Red flag: Cloud concerns
While it's hard to find many things to dislike about Alphabet at this moment, investors can point to Google Cloud, the cloud infrastructure segment, as one possible negative aspect. For starters, it still lags well behind rivals Microsoft Azure and Amazon Web Services globally in terms of market share, estimated at 11% right now. And in the most recent quarter, Google Cloud's revenue of $8.4 billion missed Wall Street expectations by $230 million, which might be the reason why the stock took a hit following the earnings announcement.
While the year-over-year growth of 22% was still healthy, it was slower than Azure's 29% growth, meaning that market share was certainly given up to the larger competitor. Because many analysts see the cloud division as a platform to introduce artificial intelligence (AI) products and services to corporate clients, any weakness in terms of revenue growth will almost certainly be viewed as a major red flag among investors. Perhaps there are notable worries that Alphabet could be falling behind a business like Microsoft when it comes to AI innovations.
However, there is an easy argument to be made that this company will be a leader as it relates to this new technology. The management team is focused on improving AI by making progress in areas like knowledge and learning, boosting creativity and productivity, enabling developers, and making AI safe and responsible to use. Plus, with internet products and services that are used by billions of people worldwide, Alphabet has a wide audience with whom it can test its innovations.
Investors who might be concerned about Google Cloud still have reasons to be optimistic when looking at the bigger picture.
