Alphabet (GOOGL) (GOOG) is the parent company of many iconic companies like Google, YouTube, and the Android operating system. While that may seem like a diverse lineup, the reality is these all generate revenue the same way: advertising.
This concentration hasn’t worked in Alphabet’s favor recently, with the stock currently down about 30% from its all-time high, primarily due to a weak advertising market.
However, this downturn is temporary, and I think Alphabet could be at a generational buying point for a few key reasons. So let’s examine those reasons and discover why there has seldom been a better time to buy Alphabet’s stock.
Alphabet’s revenue tends to fall before an economic downturn
As mentioned, 78% of Alphabet’s revenue comes from advertising. When corporate spending tightens, the first expense to get reduced is advertising. This harms Alphabet tremendously, as Alphabet’s advertising revenue declined by 4% in Q4 when compared to last year’s revenue.
But this isn’t the end for Alphabet. In fact, the company has historically displayed better-than-average revenue growth immediately after some economic downturn occurs.
The orange line in the chart indicates the probability of a recession. Each time this line begins to spike, the economy saw some cracks, although it doesn’t necessarily mean an outright recession. This caused many companies to tighten their ad spending, but as soon as the worry was over, it came roaring back.
From a historical perspective, Alphabet may have a tough time this year, but 2024 will be much better. Wall Street analyst projections also back this up. Analysts think Alphabet will grow its revenue by 4.8% in 2023 and 11.5% in 2024.
So what does that mean for the stock?
Alphabet’s hiring spree affected its margins
With the current status of falling advertising revenue, its revenue per employee isn’t optimized. That means its operating margins are coming under pressure, which was evident in Q4, as they fell from 29% in 2021 to 24% in 2022.
Another influence on this number is Alphabet’s aggressive hiring practices, as the company added nearly 34,000 employees throughout 2022. With this workforce mainly focused on artificial intelligence (AI) and other technical roles, investors may not see the value these workers add to the company for a while. Still, the company began cutting jobs, with about 6% of the workforce being laid off in January.
Even though Alphabet received criticism for its hiring spree, revenue per employee is still above pre-pandemic levels and within reach of an all-time high.
If investors are patient, these new employees will likely be able to add significant value to the company, which could boost earnings.
The stock trades as it will never recover from its current difficulties
So we’ve seen that Alphabet’s revenue is artificially low and that its operating margin will likely improve as the company’s new employees are brought up to speed. Therefore, the future is quite bright for Alphabet’s finances. Still, investors aren’t convinced, as the stock trades at the lower end of its decade-long average price-to-earnings (P/E) ratio.
High revenue with the same margins will increase earnings, but higher revenue with improving margins will lead to massive earnings growth. These two components will make the denominator of the ratio get larger, making the stock seem even cheaper than it is right now.
If you utilize projected 2024 earnings, Alphabet trades at 17.4 times forward earnings. That’s cheap for one of the most influential companies on Earth, which means investors shouldn’t hesitate to take a position in Alphabet stock right now due to its future potential.
— Keithen Drury
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Source: The Motley Fool