Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG) shares have declined by nearly 39% over the past year, as investors have been increasingly worried about declining ad spending in 2023. The ongoing macroeconomic headwinds are expected to slow down economic growth next year, which should also decrease global advertising spending. Since Alphabet makes most of its money from ads, its earnings will likely take a further hit in Fiscal 2023. Nevertheless, Alphabet stock appears cheap against its future earnings-growth potential. Accordingly, I am bullish on the stock.
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Why is Alphabet Sensitive to Macroeconomic Headwinds?
Alphabet’s performance is quite susceptible to macroeconomic headwinds because most of its revenues are sourced from advertising on search platforms and YouTube. Specifically, in its most recent Q3 report, total advertising revenues came in at $54.5 billion, which calculates to about 89% of its total revenues for the quarter. Therefore, if global advertising spending were to take a significant hit next year, so will Alphabet’s earnings, but why is this likely to occur?
Lack of Real GDP Growth in 2023
Well, following 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 come in at 0% in 2023. When the economy is performing poorly, companies are likely to record lower profits and declining revenues, which can result in budget cuts and a decrease in advertising spending. This is usually regarded as a way for companies to trim costs and uphold profitability in tough economic situations.
Softer Consumer Spending
If the economy performs poorly, one of the relatively certain outcomes can be declining consumer spending, which can affect advertising spending further. As consumers trim their expenditures, companies are likely to see a drop in demand for their products or services. This, in turn, is likely to lead them to squeeze their advertising budgets in order to save money.
Consumers Favoring Lower-Ticket Products and Services
Another factor that is in place here is changes in consumer behavior. Essentially, economic downturns are likely to cause consumers to turn towards lower-priced, lower-margin products. These products leave little to no room for companies to assign high ad spending on them. Consequently, Alphabet’s advertising revenues could decline even if ad volumes were to remain the same, just because the products and services advertised are lower-ticket.
Rising Expenses Will Cut into Profit Margins
Alphabet’s expenses have been growing quite substantially. In Q3, the company’s headcount stood at 186,779, up 24.5% year-over-year. If revenue growth doesn’t match Alphabet’s growing expenses, profit margins are most certainly set to decline. This was evident in the company’s quarterly results. With Q3 revenue growth coming in at 9%, Alphabet’s EBITDA and net margins fell to 30.7% and 20.1%, down from 37.4% and 29.0% in the prior-year period, respectively. Thus, Alphabet’s margins could be compressed further if revenue growth doesn’t pick up in 2023.
Is Alphabet Stock a Buy, According to Analysts?
Turning to Wall Street, Alphabet has a Strong Buy consensus rating based on 29 Buys assigned in the past three months. At $125.76, the average Alphabet stock forecast implies 40.94% upside potential.
Takeaway – A Buy or Not?
As explained, Mr. Market is troubled with Alphabet’s investment case due to the adverse effects the ongoing trading environment can have on its revenues and earnings next year. That said, given how violent the stock’s sell-off has been, many investors, especially on the retail side, have been wondering lately whether Alphabet shares have reached a bottom, which could signal a buying opportunity.
In my view, this is more or less the case. Alphabet appears undervalued relative to its future earnings-growth prospects. Sure, earnings growth took a hit this year, and assuming the economy remains suppressed in 2023, Alphabet’s profits could shrink further.
Nevertheless, the stock is currently trading at a P/E ratio of 17.9x. With analysts expecting double-digit earnings-per-share growth over the medium term, however, the stock is essentially trading at a forward P/E ratio of 14.4x Fiscal Year 2024’s earnings per share. Hence, while Alphabet stock could face headwinds in the short term, its recent decline likely presents a fruitful investment opportunity for those looking to hold it over the long term.
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