Google Stock becomes a good bet in a bear market (NASDAQ:GOOG)
There has been a strong correction in the broader market over the past few months. Alphabet Inc. (NASDAQ:GOOG, NASDAQ: GOOGL) (“Google”) showed it was a good bet in this scenario with strong fundamental growth metrics. In the last quarter, turnover declared by the company $69.7 billion versus $69.9 billion expected. However, year-over-year revenue growth was 13%, which is a good number given the difficult conditions and difficult macroeconomic situation. This growth rate is also higher than all other Big Tech peers. It should be noted that the strengthening dollar further reduced revenue growth by 3.7%, according to chief financial officer Ruth Porat.
Google shows improvement in hardware, subscription, and cloud business. All of these activities can help the company achieve good growth over the next few years, even if we see a market correction or a short recession in the overall economy. Google also undertook massive stock buybacks of $13.3 billion in the last quarter. Share buyback over the past twelve months was $52 billion. This is enough to write off almost 4% of outstanding shares each year. A modest P/E multiple, solid growth indicators and buybacks should boost Alphabet’s long-term return potential and make it a good bet in the current environment.
Continuation of the correction phase
It is difficult to predict how long the current phase of correction will continue. However, if geopolitical tensions continue, we could see a rise in commodity prices, which can have a knock-on effect on inflation and lead to bearish sentiment on Wall Street. Even after the current correction, the total US market capitalization as a % of GDP is quite high. We can look at the peak of the dotcom bubble when this metric was below 140%. Currently, the total US market capitalization as a % of GDP stands at 151%. If the headwinds in the broader economy continue, we could see a continuation of the correction phase.
Figure 1: US market capitalization as a percentage of GDP.
In this phase of correction, it is important to have a portfolio capable of withstanding bearish sentiment and companies capable of generating sustainable growth.
Google is a high growth story
Google has built a number of levers that should generate long-term growth. One of the main activities is hardware. The company is second in smart speakers and smart home devices, behind Amazon (AMZN). It also increased Pixel unit sales estimates to 10 million this fiscal year. That’s significantly lower than Apple’s (AAPL) unit sales of over 200 million iPhones. But Google has one of the best brand images among Android OEMs. The 5G era has also led to rapid growth in the average selling price of other Android OEMs due to higher costs. At the same time, Google is releasing budget Pixel phones with high specs that have narrowed the price gap with other manufacturers.
Pixel’s growth will also be supported by increased subscription activity. Google has already launched Pixel Pass where customers can use all of the company’s subscription services as well as a new Pixel device every two years. This spreads the cost of Pixel devices over a longer period and reduces sticker shock for customers. Google has reported over 50 million subscribers on the YouTube Premium and YouTube Music platform. That number could grow rapidly as the company expands benefits for subscribers while reducing options for non-subscribers.
Figure 2: Strong Growth of Advertising Core and Google Cloud.
Another major long-term bullish story for the company is Google Cloud. Despite a slight slowdown, the company reported an annualized cloud service revenue rate of over $25 billion with a 35% year-on-year growth rate. This service is still showing massive losses, but as revenue grows, we should see better economies of scale.
If Google is able to close the margin gap with Amazon’s AWS, the cloud service will become a major driver of margin expansion. At the current growth rate, the cloud service is expected to reach a revenue rate of $100 billion by 2025. AWS has posted a 30% operating margin in recent quarters. If Google Cloud reports a modest 20% margin, it will add $20 billion to the company’s operating profit by 2025.
The main reason Google is a better bet to protect returns in a recession is because of its cheap valuation multiple. Google has a higher annual growth rate than other Big Tech peers and has a number of strong growth drivers. Despite these factors, it is trading at a modest P/E multiple. The cheap valuation should allow the stock to rebound more quickly in the event of a major recession.
Figure 3: Comparison of year-over-year revenue growth and P/E ratio of Big Tech companies.
Alphabet has posted better year-over-year revenue growth rates compared to other big tech companies in recent quarters. In the last quarter, Alphabet reported revenue growth of 13% year-on-year, compared to 7% for Amazon, 2% for Apple and minus 1% for Meta Platforms (META). Meanwhile, Alphabet’s P/E multiple is a modest 20.5 compared to 25 at Apple and 60 at Amazon.
Alphabet’s management also spends heavily on buyouts. In the last quarter, the company repurchased $13.3 billion worth of stock and in the last twelve months it repurchased $52 billion worth of stock. Alphabet can continue and even increase the pace of redemptions due to its huge cash reserves and gargantuan free cash flow. As the cloud service achieves economies of scale, we should see better margins in this segment. Much of these additional resources could be spent on buyouts as the company does not have many businesses that require huge cash injections.
Takeaway for investors
The US stock market is going through a correction phase. This phase may continue for some time due to macroeconomic headwinds. Alphabet stock is a good bet due to its modest valuation multiple compared to other tech companies and future growth prospects.
Google has already shown good progress in the hardware area where it leads in several categories. This will be a major driver of future revenue growth as new product lines are launched. Pixel sales are also improving, which should help the company’s subscription business and reduce the cost of acquiring traffic in the long run.
Expanding margins in the cloud business will be the main reason for improved operating results and profits over the next few years. Due to these factors, Alphabet stock appears to be a better alternative compared to many other tech players.