2022 has been a tough year for the stock market with the kind of fast growth tech stocks that have fuelled its rise over the last decade hit particularly hard. The Alphabet share price has not escaped the sell-off sparked by a plunge in investor sentiment caused by soaring inflation, rising interest rates and a looming global recession of hard to predict severity.
Google’s parent company has lost over 30% of its value this year and is down 5% in the last month alone. But it still dominates online advertising with, according to Statista data, 28% market share of net digital advertising revenue worldwide.
Net digital advertising revenue share of major ad-selling online companies worldwide from 2016 to 2023
Source: Statista
Some analysts have announced the recent drop in Alphabet’s valuation means now is the best time in a decade to invest in Google’s parent company. Let’s look at the arguments that support that claim and the counterarguments that highlight threats to Alphabet and why it might not be as cheap as it looks at the current share price.
Arguments why the Alphabet share price looks more attractive than it has in years
Alphabet’s valuation decline this year can be put down to two main reasons. The first is the global macroeconomic environment of higher inflation than we’ve seen in decades. Interest rates are rising to combat that and the general presumption we are at the beginning of a recession that will hit most of the world.
The second is an overall decline in ad spend in 2022 compared to 2021 due to a combination of weak business sentiment on recession fears and the end of the pandemic and boost to the digital economy provided by lockdown restrictions and.
Revenue of Alphabet from 1st quarter 2014 to 2nd quarter 2022(in million U.S. dollars)
Source: Statista
However, despite the dip in quarterly revenues between the end of last year and the beginning of this one, which as the chart shows is not unusual despite the mitigating circumstance of the end of pandemic restrictions, Alphabet’s revenues remain huge and show plenty of potential for further growth.
The company is also still very much on track to achieve strong full-year revenue growth. Its second quarter results showed 13% growth on the same period in 2021 and $137.7 billion flowed into Alphabet’s coffers over the first half of the year compared to $117.2 billion a year earlier. It will be a big surprise if double-digit growth, part of a multi-year trend, is not achieved this year. By contract, Meta Platforms, Facebook’s holding company and Alphabet’s closest competitor for digital ad spend market share, saw its Q2 revenue contract.
While new digital platforms, especially TikTok, are growing their market share of digital ad spend, Alphabet’s Google search engine appears far less vulnerable than Facebook. Its search term-based system for serving ads is also much less vulnerable to changes in privacy policies like Apple banning the use of cookies that track users across apps than competitors like Facebook.
Google is also not just the search engine that bears the name but the company, which itself falls under the broader umbrella of the Alphabet holding company. It also owns YouTube, the Android mobile operating system that holds 71.62% market share compared to 27.23% for Apple’s iOS as of September 2022, the Chrome internet browser which has a global market share of 65.7% to second placed Apple Safari’s 18.66%.
The Google Cloud cloud computing platform, the world’s third largest after AWS and Microsoft Azure, is also growing quickly – 47% last year and 39% over the first half. It now brings in a growing contribution to group revenues – $19.2 billion from $137.7 billion or 5% in 2017 to 9% this year. That contribution is expected to keep rising over the next several years with cloud computing growth picking up some of the slack from declining growth in online advertising as the sector matures.
The cloud computing market’s value is forecast to grow from $706.6 billion last year to $1.3 trillion by 2025 and Google Cloud’s revenue will continue to expand with the market.
Google also owns the wearables company Fitbit and smart homes appliances brand Nest, which are also both profitable but perhaps contribute most in the form of hugely valuable data.
Aside from Google, Alphabet also owns the driverless technology company Waymo which has been a cash suck for years but could well be hugely valuable a decade from now. Waymo’s likely future is as an operating system for driverless electrical vehicles with a comparable business model to the Android mobile operating system.
It also owns companies including the UK-based AI company DeepMind, which is at the forefront of machine learning breakthroughs, life sciences company Verily, and CapitalG, the group’s VC investment vehicle.
Alphabet also has an impressive financial moat and finished Q2 with total assets of $355.2 billion compared to total liabilities of $99.8 billion while generating $12.6 billion in free cash flow.
Alphabet’s strong balance sheet and free cash flow mean it can continue with its recent policy of stock buybacks without compromising capital investment back into the business. The company’s share repurchase program has accelerated as its share price has fallen this year. Over the first half of 2022, Alphabet repurchased over 230 million shares compared to 20.3 million shares in total last year.
Alphabet’s 30% loss of value this year, while its revenues continue to grow, mean its enterprise value-to-EBIT (earnings before interest and taxes) ratio is currently at one of its lowest levels in the last decade.
On the surface, while nobody would rule out the potential for further short-term declines due to a tough macroeconomic environment, Alphabet looks cheap in the context of both its current revenues and profits and the potential for future growth across the group.
Risks to the Alphabet share price
However, while most analysts currently rate Alphabet’s stock as a strong buy, the median 12-month price target of analysts is for $140 and even the most pessimistic see little downside with the lowest price target at $100 (the high mark is $165), there are risks potential investors should consider.
Based purely on its P/E multiple, currently sitting at just 16 compared to a historical standard of over 30, Alphabet looks like it is incredibly undervalued at its current share price. However, there are of course no guarantees profits will remain as high.
What happens if Google’s ad revenues take a significant hit as a result of a global recession and/or new competition, Google Cloud grows more slowly than expected and long-term investments like Waymo and DeepMind ultimately disappoint?
Alphabet investors will have to keep a keen eye on the performance of Google Cloud over the next few years as its growth and market share faltering compared to rivals AWS and Microsoft Azure would be expected to hit the group’s value, potentially heavily. For now, future bets like DeepMind and Waymo won’t have a lot of impact, unless Alphabet’s makes unexpectedly large new investments in them the market perceives as risky. But over future years, signs the cost sunk in them will be lost or fail to realise a major return on investment would raise major doubts over long-term growth potential.
In the short term, investors should pay close attention to Alphabet’s EPS (earnings per share), range, which is particularly high at the moment.
In Alphabet’s case, the forecast is an EPS mark of $5.91. And if you need the EPS to actually come in at that level to justify your investment in the business, then you’re leaving yourself no margin of safety.
The analyst consensus for next year’s EPS is $5.91. If ad revenues take a bigger hit than expected next year and were to fall to $5, Alphabet would be trade at a forward p/e of 20 on today’s share price, which is less of a bargain than the current $16. A deeper global recession dragging it down to $4 and the forward p/e rises to 25.
That still leaves a margin for error against Alphabet’s historical forward p/2 trading average. Long term investors would be very confident of a bounceback in valuation when the global economy improves.
However, while there are always risks with every investment as we don’t know what will happen in the future, all things considered, the evidence does seem to suggest Alphabet’s stock has a very strong up-to-downside profile at its current price level. It’s certainly one for investors looking for buy opportunities with a mid to long-term investment horizon to consider.
