Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) has emerged as a leading force within the tech industry, exhibiting a remarkable performance this year. With its shares skyrocketing by nearly 60%, dwarfing the S&P 500’s modest 15% returns, the company has left investors reeling with both excitement and uncertainty. The resurgent interest in tech giants, fueled by the AI fervor, has significantly bolstered Alphabet’s position in the market.
For those who have invested in Alphabet, the current surge in share prices might be prompting thoughts of securing profits at these remarkable levels. On the other hand, for those who haven’t yet entered the market, the question of whether it’s too late to benefit from Alphabet’s impressive returns might be looming large. To determine whether Alphabet is a prudent buy or sell at these prices, it’s essential to delve into the figures and discern the company’s trajectory.
Navigating market dynamics and projecting long-term growth potential
Alphabet weathered a challenging phase last year, grappling with a significant slowdown in growth, largely influenced by a reduction in marketing budgets across various industries. In the second quarter, the company’s revenue witnessed 16% year-over-year growth in constant currency, a marked deceleration compared to the stellar 57% growth achieved in 2021.
Moreover, the rapid expansion of its workforce led to a surge in expenses, outpacing revenue growth, and consequently compressing profit margins. This tumultuous phase resulted in a substantial decline of approximately 45% in Alphabet’s share price, the most extensive drop it had experienced since its inception as a public company. However, the tide has since turned, primarily driven by the resurging faith in the potential of AI and Alphabet’s concerted efforts to trim costs and prioritize shareholder interests.
These efforts have begun to yield tangible results, as evidenced by the gradual rise in operating margins. In the most recent quarter, the operating margin stood at 29%, indicating a positive trajectory compared to 2022. Additionally, there has been a revival in revenue growth, with a 9% increase on a constant currency basis in the last quarter, surpassing the 7% growth recorded in the fourth quarter of 2022.
While short-term developments are noteworthy, the long-term prospects of sustained revenue growth and profit margins are pivotal considerations. The automated nature of Alphabet’s digital advertising business provides a strong foundation for maintaining high profit margins. To this end, as long as the company exercises prudence in its hiring strategies, the prospects appear promising.
Furthermore, despite concerns about the sustainability of double-digit revenue growth, Alphabet seems poised to leverage the evolving dynamics of the global advertising industry. With its dominant position in digital advertising, including the formidable YouTube platform, the company is well-positioned to capture the transitioning market from traditional television advertising to digital formats. As a result, the continued shift of advertising budgets towards digital platforms is expected to further fortify Alphabet’s revenue streams.
Notably, Alphabet’s Google Cloud division has also demonstrated significant growth, with a 28% year-over-year revenue increase, surpassing $8 billion in sales in the last quarter. As businesses continue to transition to cloud computing infrastructure, this segment is poised to be a key driver of Alphabet’s revenue growth in the coming years.
However, despite these promising prospects, caution is advised in the current market scenario. With the stock’s price-to-earnings ratio (P/E) reaching close to 30, the stock appears relatively expensive, offering an earnings yield of just 3.3%. Contrastingly, short-term Treasuries currently yield 5.5%, emphasizing the risk associated with acquiring Alphabet shares at the current valuation. Consequently, it might be prudent for investors to await a more favorable entry point, ideally when the stock hits a P/E of 15 to 20, closer to its initial valuation at the beginning of the year.
Nevertheless, for long-term shareholders of Alphabet, it might be advisable to tread cautiously, considering potential capital gains taxes that could significantly impact investment returns. Consequently, a hasty sale solely driven by a slightly elevated earnings ratio might not be the most judicious approach. As such, maintaining Alphabet on the watchlist as a high-quality business with substantial growth potential seems like a prudent strategy for long-term investors.
In the fast-paced world of the stock market, the decision to buy or sell Alphabet shares remains a matter of careful evaluation and patience, underscoring the importance of a balanced approach that considers both short-term market dynamics and long-term growth potential.
