As a digital technology expert, I‘ve been closely following the precipitous drop in the stock price of Google parent company Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL). In 2022, GOOG stock is down over 30% and recently hit new 52-week lows after a disappointing Q3 earnings report.
In this article, I‘ll dive deep into the factors behind Google‘s stock decline, examine the company‘s financials and competitive position, and share my perspective on whether this pullback represents a buying opportunity for long-term investors.
Macro Headwinds Hurting Tech Stocks
First, it‘s important to note that Google is hardly alone in seeing its stock price tumble this year. 2022 has been brutal for tech stocks across the board, with the tech-heavy Nasdaq Composite index down nearly 30% year-to-date.
High inflation, rapidly rising interest rates, and growing fears of a recession have led investors to shun riskier, growth-oriented tech stocks in favor of more defensive sectors. The Fed funds rate has jumped from near zero to over 3% in 2022, one of the fastest hiking cycles on record. This makes future earnings less valuable in today‘s dollars.
In this environment, companies whose revenues rely heavily on advertising spending are particularly vulnerable, as marketing budgets are often among the first things cut when the economy slows. We‘ve seen the likes of Meta Platforms (Facebook), Snap, and Twitter get hammered for this reason.
Lapping Pandemic Comps and Prior Highs
The drastic decline in Google‘s stock price is also a result of tough year-over-year comparisons. Like many tech companies, Google saw its business accelerate during the pandemic as lockdowns drove more online activity. In 2021, the company grew revenue by 41% to $258 billion while net income surged 89% to $76 billion.
Fueled by these stellar results, GOOG shares rallied 65% in 2021 to hit an all-time high of $151.55 in November. At its peak, the stock traded at a historically lofty valuation of over 30 times forward earnings. While Google‘s dominant competitive position and growth prospects arguably justified a premium multiple, a pullback from such elevated levels isn‘t shocking.
Dissecting Google‘s Q3 Earnings Miss
Google‘s latest leg down came after the company missed analyst estimates on both the top and bottom lines in Q3. Here are the key numbers:
| Metric | Q3 2022 | Q3 2021 | Change |
|---|---|---|---|
| Revenue | $69.09B | $65.12B | +6.1% |
| EPS (diluted) | $1.06 | $1.40 | -24.3% |
| Operating Income | $17.14B | $21.03B | -18.5% |
| Operating Margin | 24.8% | 32.3% | -750bps |
Source: Alphabet Q3 2022 Earnings Release
Digging into the details, a few things stand out:
-
It marked Google‘s slowest revenue growth rate since 2013 (excluding one pandemic-affected quarter in Q2 2020). The strong dollar was a major headwind, as constant currency revenue would have been up 11%.
-
YouTube ad revenue declined 2% year-over-year to $7.07 billion, badly missing estimates for modest growth. Management blamed pullbacks in spend from sectors like insurance, loans, mortgages, and crypto.
-
Operating income declined 18.5% due to rising costs and a hiring spree. Total headcount jumped 24% year-over-year to 186,779. As a result, operating margin contracted from 32% to 25%.
-
Other Bets, which houses experimental projects like self-driving unit Waymo, saw losses widen to $1.61 billion from $1.29 billion a year ago on small revenue base. It reignited concerns about Google‘s spending on non-core initiatives.
Still a Digital Advertising Powerhouse
Despite the Q3 hiccup, Google remains the 800-pound gorilla in digital advertising. Let‘s put its scale and industry position into context.
In 2022, worldwide digital ad spending is expected to reach $602 billion, up 15.6% from 2021, according to research firm eMarketer. By 2024, that figure is projected to top $876 billion. For comparison, TV ad spending is estimated at just $180 billion this year.
Google is the leader in several key digital ad market segments:
| Segment | Market Share |
|---|---|
| Global search ads | 58.4% |
| U.S. digital ads | 28.6% |
| U.S. digital video ads | 25.2% |
| Global mobile ads | 21.3% |
| Global digital ad spend | 18.7% |
Source: eMarketer, company reports
In search, Google has an effective monopoly with nearly 60% share globally and over 80% in most major markets outside of China. It handles more than 8.5 billion searches per day across a wide range of monetizable verticals from consumer products to travel to local business queries.
Google‘s Search strength creates a powerful network effect as more usage improves its algorithms, ad targeting, and ability to drive ROI for advertisers. That keeps ad budgets flowing its way. eMarketer projects Google will generate $176 billion in search ad revenue in 2022, up 15% year-over-year.
YouTube is also a major force, though clearly seeing some pressure from TikTok lately. The platform has over 2 billion monthly active users globally and reaches more 18-49 year-olds in the U.S. than any TV network. While YouTube ad revenue slipped last quarter, it still topped $28 billion for the trailing 12 months.
Antitrust Scrutiny and Regulatory Risks
One perpetual overhang for Google shares is the threat of regulatory action to curb the company‘s power, especially in search and digital advertising. The company faces antitrust lawsuits from the U.S. Department of Justice and several state Attorneys General alleging it has monopolized various markets through anticompetitive practices.
These suits are likely to drag on for years and their outcomes are highly uncertain. But some of the more aggressive potential remedies, such as forcing a breakup of Google‘s businesses or placing strict limits on its ability to favor its own services, would be clear negatives for the stock if implemented.
Lawmakers are also discussing new legislation to rein in Big Tech, including the American Innovation and Choice Online Act which could prohibit Google from self-preferencing in search results. While passage of such bills in the current divided Congress seems unlikely, the risk can‘t be dismissed.
Outside the U.S., Google has already been hit with several billion dollars worth of fines by the European Commission related to Android, comparison shopping, and AdSense. Continued pushback from international regulators is a persistent risk.
Rising Competition and Headwinds
Google may be dominant in search and digital ads today, but it‘s not without competitive threats. The rise of Amazon‘s advertising business looms large. While small compared to Google‘s, Amazon‘s ad revenue is growing rapidly, topping $37 billion in 2022.
As the leading e-commerce destination, Amazon has incredibly valuable purchase intent data it can use to target ads. The company has also been steadily increasing the ad load on its site and apps. A lot of consumer product searches now start on Amazon, pressuring Google‘s most valuable ad real estate.
Google‘s network business, which includes ads on third-party websites, is also facing challenges from the likes of The Trade Desk and Microsoft‘s Xandr division. The Trade Desk has been successfully building an alternative ad-buying platform focused on connected TV and is winning share with its privacy-centric approach.
Apple is another thorn in Google‘s side. The iPhone maker‘s ATT (App Tracking Transparency) initiative, which requires users to opt in to cross-app tracking, is making it harder for advertisers to target and measure their campaigns. Meta has said ATT would cost it $10 billion in revenue in 2022. While Google has more first-party data and is less exposed, it‘s not immune.
In digital video, TikTok has emerged as a massive threat to YouTube. The short-form video app now has over 1 billion monthly active users and is becoming a bigger destination for brand ad dollars. While YouTube has responded with Shorts, monetization is still nascent. TikTok‘s incredible engagement could steadily siphon both eyeballs and revenue if current trends continue.
Valuation Reset Creates Opportunity
There‘s no sugarcoating the fact that 2022 has been a painful year for Google shareholders. And with the economic outlook uncertain, more downside is certainly possible in the near term.
However, for investors with a multi-year time horizon, the significant compression in Google‘s valuation looks overdone relative to its still-strong fundamentals and long-term growth prospects. At current prices around $90, GOOG trades at less than 18 times forward earnings, its lowest level since 2019.
That‘s only a slight premium to the S&P 500‘s forward P/E of 16x, despite Google‘s far superior growth and profitability profile. The stock also trades at just 14 times forward EV/EBITDA. Google‘s balance sheet is a fortress, with over $116 billion in cash and marketable securities. It essentially has no net debt.
Free cash flow generation also remains robust at $16 billion last quarter and $63 billion over the last 12 months. That‘s good for a 5.4% free cash flow yield at the current market cap. Google is aggressively returning that cash to shareholders, with $15.4 billion in Q3 buybacks, putting it on track to repurchase nearly 5% of its shares outstanding in just one year.
While growth has decelerated, Google is still putting up double-digit revenue and operating income increases on an FX-neutral basis. With over $200 billion in annual sales, that‘s impressive. And the longer-term trajectory remains positive, with multiple secular tailwinds.
Even in a recession, search advertising is likely to be relatively resilient as businesses prioritize spending on bottom-of-funnel tactics that drive measurable returns. And as linear TV viewership declines, YouTube should be a prime beneficiary of brand ad budgets shifting to streaming video. YouTube Shorts momentum is also encouraging.
Google Cloud, while still unprofitable, grew revenue 38% to nearly $25 billion in 2022. That business has plenty of room for margin expansion as it gains scale. Waymo, while still experimental, has the potential to be a massive value creator if self-driving technology can be commercialized at scale.
The Bottom Line
Make no mistake, Google faces real challenges. A potential recession will likely pressure results in the coming quarters. Competition from Amazon, Apple, TikTok and others is heating up. And the regulatory environment remains a wild card.
However, Google‘s current headwinds look more than reflected in its compressed valuation. Digital advertising is a secular growth market and Google is the clear leader with an incredibly wide moat stemming from its search dominance. The company also has numerous other irons in the fire, from YouTube to Cloud to moonshots like Waymo.
With a rock-solid balance sheet, prodigious cash generation, and a management team laser-focused on AI innovation, Google is well equipped to navigate near-term volatility and drive long-term growth. For patient investors willing to look past the current noise, the stock‘s 2022 decline may ultimately prove a rare buying opportunity in a true generational company.
As always, investors should do their own due diligence and assess their individual financial goals and risk tolerance before making any investment decision. But in my view, Google‘s risk/reward looks quite compelling at current levels for those with a long-term horizon.
Disclosure: I own shares of Alphabet (GOOG, GOOGL) as of this writing.
