Letters (NASDAQ: GOOGL) (NASDAQ: GOOD) shares are down nearly 39% over the past year as investors grow concerned about falling ad spending in 2023. Ongoing macroeconomic headwinds are likely to slow economic growth next year, which should also reduce global advertising spending. With Alphabet making most of its money from ads, its earnings are likely to take another hit in fiscal 2023. Still, Alphabet stock looks cheap relative to its future earnings growth potential. Accordingly, I am bullish on the stock.
Why is Alphabet sensitive to macro headwinds?
Alphabet’s performance is fairly vulnerable to macroeconomic headwinds, given that most of its revenue comes from advertising on search platforms and YouTube. Notably, total advertising revenue was $54.5 billion in the most recent Q3 report, accounting for about 89% of total revenue for the quarter. So if global adspend takes a significant hit next year, Alphabet’s revenue will suffer too, but why is that likely?
No real GDP growth in 2023
Well, after a rigid macro environment in 2022, the economy is expected to perform poorly next year. In fact, real GDP growth in the United States is expected to be 0% in 2023. When the economy performs poorly, companies are likely to see lower profits and declining revenues, which can lead to budget cuts and a drop in advertising spending. This is usually viewed as a way for companies to cut costs and maintain profitability during tough economic times.
Softer consumer spending
If the economy performs poorly, one of the relatively safe outcomes can be falling consumer spending, which can further impact adspend. As consumers cut back on spending, businesses are likely to see a drop in demand for their products or services. This, in turn, will likely prompt them to cut their advertising budgets to save money.
Consumers who prefer cheaper products and services
Another factor that comes into play here is changing consumer behavior. Essentially, economic downturns are likely to result in consumers turning to lower-priced, lower-margin products. These products leave companies little to no leeway to attribute high advertising spend to them. As a result, even if ad volume stays the same, Alphabet’s advertising revenue could decline simply because the advertised products and services are cheaper.
Increasing spending will eat into profit margins
Alphabet’s spending has increased quite a bit. In the third quarter, the company’s headcount was 186,779, up 24.5% year-on-year. If revenue growth doesn’t match Alphabet’s growing spending, profit margins are sure to shrink. This was reflected in the company’s quarterly results. With revenue growing 9% in the third quarter, Alphabet’s EBITDA and net margin declined to 30.7% and 20.1%, respectively, compared to 37.4% and 29.0%, respectively, in the year-ago period. Therefore, Alphabet’s margins could be squeezed further if revenue growth doesn’t pick up in 2023.
Is Alphabet Stock a Buy According to Analysts?
As for Wall Street, Alphabet has a strong buy consensus rating based on 29 buys assigned over the past three months. At $125.76, the Alphabet stock average forecast implies a 40.94% upside potential.
Takeaway – buy or not?
As previously discussed, Mr. Market is concerned about Alphabet’s investment case due to the adverse impact that the ongoing trading environment may have on its revenue and earnings over the next year. Recently, given the stock’s sharp sell-off, many investors, particularly in retail, have wondered if Alphabet stock has bottomed, which could signal a buying opportunity.
In my view, that is more or less the case. Alphabet appears undervalued relative to its future earnings growth prospects. Sure, earnings growth has taken a hit this year, and assuming the economy stays subdued in 2023, Alphabet’s earnings could shrink further.
Still, the stock is currently trading at a P/E of 17.9. However, with analysts expecting double-digit earnings per share growth over the medium term, the stock essentially trades at an expected P/E of 14.4x fiscal 2024 earnings per share. Although Alphabet stock could face near-term headwinds, its recent drop likely offers a fruitful investment opportunity for those looking to hold it for the long term.
End of Year Special Offer: Access TipRank’s premium tools at a rock-bottom price! Click to learn more.
disclosure
Comments are closed.