4 Reasons Google is a Buy (NASDAQ:GOOG)

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Sean Gallup

introduction

Alphabet, Inc. (NASDAQ:GOOG) (NASDAQ:GOOGL) has not been a gratifying choice for investors over the past six months; at a time when the benchmark has delivered positive returns of around 4%, the stock has seen a fifth of its market capitalization wiped out.

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Investors have mostly shunned the stock due to macro concerns and what that could do for advertising-related spending. Admittedly, in an uncertain economic environment like this, customers are unlikely to be eager to devote too many resources to their respective advertising budgets. But investors also shouldn’t ignore the challenges of churning out elite growth rates when your base year is this strong; this high base effect is likely to persist and only ease by the end of Q1-23.

However, if investors can be a little more open minded and look beyond the decline in ad spend, I believe there are still many other encouraging subplots that support a BUY case.

Here are 4 reasons I’m bullish on the stock right now.

Operating dynamics could improve

Operationally, Alphabet hasn’t been doing very well lately; After a flat performance in Q2-22, third-quarter operating profit decreased 19% year over year. While higher data center and hardware costs have played a role, don’t underestimate the impact of an aggressive hiring trajectory on your cost base.

From Q2 to 21, the number of additions in different verticals (R&D, sales, etc.) increased every single quarter; in fact, over the past 5 quarters, we have seen a more than 3x increase in headcount additions per quarter (in Q2 and Q3-22, year-over-year headcount growth reached a whopping 149% and by 113%).

Transcripts of quarterly earnings

Fortunately, things appear to have peaked here, and going forward we will see a dramatic reversal in the hiring trajectory through 2023. Alphabet’s CFO said fourth-quarter hiring will be about 50% below levels seen in Q3; this should reduce the headcount increase to less than approximately 6400 employees, which would represent a decrease in annualized terms (fourth-Q21 increases were 6500 employees).

A less expansionary workforce strategy should start to make a positive mark on Alphabet’s operating leverage going forward. For example, consider that in FY23, Alphabet’s earnings per earnings growth (10.7% YoY growth) will outpace revenue growth (8.7% YoY growth) by 1.24 times, but in FY24 it will further improve to 1.34 times (17% growth on the bottom line, vs 12.7% on the top line).

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In addition to a slower pace of hiring, over the medium term, currency dynamics are expected to be reflected favorably on operating cost basis. In the second and third quarters, FX had dampened Alphabet’s reported revenue by 300 basis points and 500 basis points, respectively. Since most of Alphabet’s research and development is based in the United States, dollar strength tends to weigh even more negatively on the cost basis. In October, Alphabet’s management said it expected an even bigger negative impact from FX in the fourth quarter, but I believe it won’t be as negative as initially expected, as the dollar has corrected about 7% since then. results published by Alphabet. DXY has also recently fallen below a base it had formed since early December 2022, which does not bode well for its outlook.

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The upright cloud could prove to be a dark horse in this environment

While advertising appetite could likely remain subdued in a challenging macroeconomic environment, I don’t think the same can be said for business-related spending on cloud initiatives which will continue to remain resilient due to the cost advantages and efficiencies that potential customers can get . Rather than focusing on infrastructure management and neglecting projects, customers can entrust this task to the expertise of cloud providers like Google who provide managed services, managed databases, managed warehouses, etc. at competitive prices. The incentive to drive greater productivity through cloud initiatives shouldn’t be ignored.

Also, rather than pursuing big-bang CAPEX projects to build their infrastructure in this environment, I suspect many customers would prefer to spread costs and move to a subscription-oriented model that could drive FCF generation.

All in all, Gartner believes that global spending on public cloud services will actually grow by an even larger margin this year, despite the high FY22 base effect; Global public cloud spending grew 19% in FY22 and is likely to grow 21% this year!

Gartner

Some of you may be wondering if Google Cloud can leverage the conditions here, given its relatively low 11% market share, which is more than 3 times smaller than Amazon’s AWS (Microsoft Azure has a 21% market share meanwhile). %). a competitive offering that could generate a lot of traction (particularly with smaller customers) in this environment, as it’s priced quite competitively. Ascertaining a one-size-fits-all price comparison can be difficult given how different pricing models vary between companies, but a helpful study conducted by Megaport in November of last year showed that the per-spec cost of Google Cloud Platform ( GCP) (25-26% relative off its peers while offering 8GB RAM and 2 processors at the lower end) were pretty compelling. Even at the top end, the offering isn’t all that bad.

Megaport

Also, for the uninitiated, in the recently concluded third quarter, Google Cloud actually outperformed its larger competitors with GCP growth at a faster rate.

The valuation angle suggests this opportunity is too good to pass up

YCharts estimates point to a FY23e EPS figure of $6.20; this would imply a 1-year P/E multiple of just 14.9x. That multiple seems criminally low, for a ubiquitous tech company that continues to make a strong footprint in the twenty-first century. Even if you want to dismiss it as plain nonsense and just talk numbers, consider the degree of earnings growth you’re getting at that multiple.

As noted in the previous section of this article, you’re looking at a pretty impressive earnings growth of 17% in FY24. AP/E of 14.8x would then translate into a low PEG ratio of less than 1 (just 0.87x), a figure you’d typically associate with a serious, defensive stock with limited growth prospects. It’s also worth noting that Alphabet’s current P/E multiple is roughly 38% down on its 5-year average multiple.

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In the meantime, it also helps this company has a long and consistent track record of generating free cash flow, something that would be hugely critical to funding its growth ambitions, without getting bogged down with an overdose of external funds. If you’re chasing Alphabet stock at this juncture, you’ll enter when the FCF yield is near record highs of over 5.1%, a full 180 basis points higher than its historical average of 3.34%.

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All in all, I just feel the opportunities to own an elite tech brand like Google at such discounted valuations aren’t going to present themselves too often.

Decent risk-reward on charts supported by growing institutional interest

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Midway through last year, it was questionable whether one should jump into owning GOOG stock as it looked vastly overbought relative to its peers on the Nasdaq. That is no longer the case as the ratio has reverted to its mean, trading at the midpoint of its permanent range.

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Beyond that, you could also see an increase in buying interest considering developments on Alphabet’s weekly chart. Note that the stock has followed a downward channel since the peak in November 2021. I could not be definite but there is a reasonable likelihood that it will attempt to bottom at current levels as this also coincides with an old congestion zone seen in late 2020 and early 2021. Also, after bottoming out in late October 2022, there was another attempt to drive the stock down, but it failed with many wick candles (reflecting the impact of business). Even if you aren’t willing to hold the stock for too long, the risk-reward ratio across the boundaries of the descending channel doesn’t look too shabby at this price point.

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Finally, also note that the people with deep pockets — the institutional brothers — have also started to get constructive about Alphabet. GOOGL saw an increase in the net shares held by these institutions in November itself, while interest in GOOG increased last month.

Closing thoughts

Given the headwinds related to the core advertising business, the recovery in Alphabet stock is unlikely to proceed apace. However, as noted in this article, there are several other encouraging narratives that make this gamble intriguing. The alphabet is a PURCHASE.

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