Google: This is when I’ll start shopping (NASDAQ: GOOG)

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Alena Kravchenko

investment thesis

alphabet (NASDAQ:GOOG) (NASDAQ:GOOGLE) continues to be challenged by the current macroeconomic environment, as advertiser demand remains weak amid an uncertain future. That said, I think Alphabet is going ahead with its top priorities around Search and AI, YouTube, Hardware and Google Cloud as it seeks to improve operational efficiency in response to the uncertain environment. I continue to see Alphabet as one of the best positioned companies in the internet sector as it continues to have strong fundamentals in a weaker macro environment and its core competitive advantage in search looks good as it continues to invest in AI and learning. automatic. capabilities.

I think the time to buy Alphabet is when the demand for advertising bottoms out, which would imply that Alphabet’s ad-related revenue would bottom out and therefore the stock would bottom out. This usually happens when expectations bottom out and, as a result, when sell-side analyst earnings-per-share estimates show signs of bottoming out. As such, I will continue to monitor ad demand as well as sell-side analyst expectations revisions to determine when it will get closer to when I will be more constructive on the stock. That said, with a forward P/E multiple of 14x to 2023, this is already attractive compared to the 2008 financial crisis low of 17x P/E, and for investors not looking to time the market, it is now a good time to increase the position in the stock market.

Advertising demand weighed down by macro challenges

With the latest quarter to come, the key challenge facing Alphabet is the challenging macroeconomic environment, which is negatively impacting demand from advertisers. As a result, we saw Search & Other revenue growth slow to 4% year-over-year growth, while YouTube’s revenue fell 2% year-over-year. The weakness was due to a reduction in advertising spending as companies face an increasingly uncertain operating environment.

Unsurprisingly, the weakest verticals were lending and cryptocurrency verticals, while the strongest verticals were travel and retail. In my opinion, with the rising rate environment, I think the worst is yet to come, and I expect the weak ad demand is likely to continue.

YouTube Shorts’ monetization appears to be increasing, as the format now has 1.5 billion monthly viewers and 30 billion daily views. YouTube Shorts monetization began in September and the Shorts creators revenue share model will begin in 2023. YouTube continues to gain share from linear TV as viewers watched more than 700 million hours of YouTube content. YouTube daily.

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google cloud

On a positive note, Google Cloud reaccelerated to 38% YoY growth in 3Q22, up from 36% YoY growth in the previous quarter. This quarter’s growth rate was also 3 percentage points above market expectations, highlighting the resiliency in Google Cloud’s business. the $6.9 billion in Google Cloud revenue demonstrated the strong momentum we’re seeing as cloud remains a top priority for the company. With the uncertain macroeconomic environment, Google Cloud may continue to grow strongly due to the continued long-term trend of cloud adoption, as Google Cloud provides added value to customers in the form of improved productivity, lower costs and freeing up new growth drivers for clients.

in the google cloud next 2022, the company also launched more than a hundred new products and expanded relationships with customers such as base of coins (CURRENCY), Toyota (TM) and AppLovin (APP).

There are some areas within Google Cloud that have seen weakness. Management shared on their earnings call that they were seeing some deals taking longer to close, leading to some delays, as well as some deal sizes getting smaller and timeframes getting shorter than before.

In my opinion, the strong push from Google Cloud shows that the business is on the right track, as other big cloud players like Microsoft (MSFT) and Amazon (AMZN) struggled in the last quarter. For Microsoft Azure, the 42% growth rate in the latest quarter reflected a 4 percentage point slowdown from the previous quarter, while its guidance for the coming quarter implies a further 5 percentage point slowdown in the next quarter for Microsoft. Azure. Amazon’s AWS grew 28% last quarter, reflecting a 5 percentage point slowdown from the previous quarter and missing market expectations by 4 percentage points. In terms of margins, Google Cloud was also an outlier, seeing a margin improvement of 2.7 percentage points to roughly -10% of segment operating margins, while Amazon’s AWS saw a decline of operating margins of 4 percentage points in the latest quarter as a result of headwinds from higher energy. costs, which Microsoft Azure also experienced.

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As a result, when I compared the results of Google Cloud and those of Amazon and Microsoft, I see that Google Cloud’s momentum remains resilient in a tough market when its peers are experiencing a slowdown as a result of workload optimization in the market. case of Microsoft and some clients reducing their experimental budgets in the case of Amazon.

Cost management in times of uncertainty

As with all big tech companies in this period of macroeconomic uncertainty, Alphabet is also focusing on managing profitability and costs. One measure highlighted by management is to reduce the pace of hiring, although this will only become more apparent in 2023.

Management indicated that for the coming quarter they will add less than half the staff they did in the third quarter, as Alphabet continues to hire for its critical and technical roles needed for its strategic growth opportunities. As the company continues to slow down the hiring pace, the results of its actions will be more apparent in 2023, in my opinion. I also think we’ll see management continue to focus on their four key priorities, such as Search and AI, YouTube (particularly Shorts monetization), Hardware, and Google Cloud. I think continued efforts to manage costs as revenue declines given a weaker macroeconomic environment and a weaker ad market are prudent, but at the same time, Alphabet will fare well on its top priorities.

Valuation

I use an equal weighting DCF method as well as a multiple P/E method to value Alphabet. For my 2023 P/E multiple assumption, I assume a 1-year forward multiple of 22x in 2023 EPS to derive my target price. For my DCF valuation, my 10-year DCF model forecast takes into account weakening macro trends that will affect Alphabet’s business in the near term. I’ve also included some weaknesses in Google Cloud to be more conservative in the short term, as we saw some weaknesses in the segment in the current quarter. All in all, I think I was conservative with my valuation of Alphabet and it pays to be cautious in this current macro environment.

My 1-year target price for Alphabet is $125, which is a 44% increase from current levels. I still think Alphabet is one of the best positioned in the internet sector and deserves to trade at a premium given its strong competitive advantage in search and continued investments in rapidly growing priorities like Google Cloud.

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risks

macroeconomic environment

The biggest risk is that the macroeconomic environment could worsen, drastically reducing the demand for advertising, causing a drop in its Search and other revenues and in YouTube’s revenues that depend on ad spend.

competitive pressures

While Alphabet is dominant in the global search market, there are still risks from other competitors as there may be competitors bypassing Alphabet’s search engine or other competitors who may create other products, applications or networks that lead to advertising investment is shifted to others. platforms For example, if advertisers see the return on ad spend on platforms like TikTok to be higher than ads placed on Google, this could lead to a loss of ad spend on Google and lead to future competitive pressures.

regulatory pressure

As with every other big tech company, Alphabet is not spared from the increasing regulatory scrutiny of these big tech companies and there is definitely an increasing focus on antitrust, data and privacy issues that if Alphabet doesn’t handle Well, it could generate more publicity. impact on the company.

conclusion

I think the time to buy Alphabet and where the reward for risk becomes very attractive is when ad demand shows signs of bottoming out and sell-side analyst expectations result in bearish earnings per share estimates for the company. That said, as explained above, Alphabet’s current valuation based on forward P/E multiple is already lower than it was when the company was in the depths of the 2008 financial crisis. I think the company looks very well positioned. within the Internet sector, as it continues to invest in its key strategic priorities even as advertising demand bites the company in the short term. Google Cloud’s strength was a positive in the quarter as the company’s cloud platform outperformed its peers, although there were pockets of weakness. Alphabet also remains cautious on spending as it seeks to improve operating efficiency to ensure it is ready for the uncertain macroeconomic times ahead. My 1-year target price for Alphabet is $125, which is a 44% increase from current levels.

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