Alphabet (GOOG) Stock Should Be Bought on Weakness

Not all is well in the Alphabet (NASDAQ:GOOG, NASDAQ:GOOGL) kingdom, and that is why GOOG stock has dropped from $1,300 to below $1,050 over the past several months.

The company’s ad revenue growth is slowing amid less robust growth rates across the entire digital advertising world and rising competition from Amazon (NASDAQ:AMZN). GOOG’s cloud business is slowing, too, largely due to Microsoft (NASDAQ:MSFT) gaining share. Moreover, Alphabet’s margins remain depressed, while its profit growth is slowing and government regulation remains a big threat.

GOOG stock is definitely facing meaningful headwinds. As a result, the recent weakness of GOOG makes sense.

But this weakness is also a long-term buying opportunity.

GOOG Still Has Some Positive Catalysts

In the big picture, Alphabet is still the king of the digital advertising world, and its digital-ad business is still growing at a 20% clip. The company’s cloud business is slowing, but it, too, is expanding by 20% annually and has long-term staying power. Alphabet’s margins are depressed, but they are starting to stabilize, thanks to slower TAC (traffic acquisition cost) growth. The company’s profit growth hasn’t been the best recently, but it’s also improving. And, while regulation is a threat, Google search is the backbone of the global internet, and it’s tough to see regulations changing that anytime soon.

Meanwhile, Alphabet stock has some major growth levers in e-commerce, self-driving, and artificial intelligence that it will gradually pull over the next several years. Considering the huge implications of those drivers, pulling any one of them could provide a huge lift to Alphabet’s growth outlook and to GOOG stock.

Overall, GOOG stock has been weak recently, and with good reason. But, for long term investors, this weakness is an opportunity. Alphabet should remain a growth leader, and as a result, GOOG should be a long-term winner.

The Near-Term Weakness of GOOG Is Warranted

Considering Wall Street is notorious for putting far too much emphasis on the most recent headlines, it is no wonder that GOOG stock has been weak as of late. All the recent headlines about GOOG have been fairly negative.

Meanwhile, GOOG’s third-quarter earnings weren’t that great, as its advertising business grew by just 20%. While that is a nice growth rate for a huge ad business, it is also a multi-quarter low and well below the trailing four-quarter average growth rate of about 23%. This slowdown indicates two things. First, it shows that growth is slowing across the entire digital advertising space. Indeed, eMarketer thinks that digital advertising growth rates will go from 20%-plus over the past several years, to 10% by 2021. Second, the deceleration of Google’s ad business confirms that Amazon is indeed stealing share from Google.

Meanwhile, Google’s other revenues (most of which are generated by its cloud business) grew by just 29%. Again, that is a nice growth rate, but it’s below the 35%-plus growth rates that segment has reported over the past few quarters. The slowdown occurred because the cloud wars have really morphed into a two-horse race between Microsoft and Amazon, with Google falling way behind.

Meanwhile, GOOG’s margins are still down year-over-year. Despite Alphabet’s 20%-plus revenue growth, its operating profits rose just 7%. Finally, looming regulation remains a headwind, as Britain recently unveiling a digital services tax that will be targeted at tech giants like Alphabet.

Overall, the recent headlines have not been pretty for GOOG. Consequently, GOOG stock has been weak, and the decline of the shares shouldn’t be a surprise.

The Long-Term Upside of Alphabet Stock Is Promising

Wall Street’s focus on the recent headlines is creating an opportunity for long-term investors.

The company’s advertising business is slowing as the whole digital advertising world slows. But everything is going digital, and within the decade, a majority of the world’s $1 trillion ad budget will be spent online. Google search, as the internet’s go-to and unchallenged search leader, and YouTube, as the internet’s go-to and unchallenged video streaming website, will control the lion’s share of that market, implying healthy long-term growth and staying power for Google’s advertising business.

Yes, the cloud business is slowing. But this is a continuous growth market with massive long-term growth prospects. Google doesn’t need to be the first horse in this race. Or the second. If it’s just a major player in the sector, it will definitely deliver 20%-plus growth for the foreseeable future.

Also, Google’s margins have dropped. But its TAC growth is moderating and TAC as a percent of revenues was stable year-over-year last quarter at 23%. That reverses what had been a multi-quarter trend of the company’s TAC rate growing year-over-year, and GOOG sounded fairly certain that this new trend will persist for some time. So Alphabet’s margins appear to have bottomed.

Meanwhile, Alphabet owns Waymo, the world’s leading autonomous driving company, and is arguably the global leader in AI given its huge database. Furthermore, GOOG could very well eventually use its search engine to build an e-commerce business. At any point, any one of those growth drivers could start having a meaningful, positive impact on Google’s financial results, and provide a huge lift to GOOG stock.

The Bottom Line on GOOG Stock

GOOG’s near-term risks are elevated, but its long-term upside is compelling. Trading at roughly 23 times its forward earnings and providing exposure to all of tomorrow’s most important growth markets, GOOG seems like a solid choice here for long-term oriented investors.

As of this writing, Luke Lango was long GOOG, AMZN, and MSFT. 

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