In general, the best time to buy stocks is when they’re out of fashion. And investors don’t seem to have much love for Alphabet (NASDAQ:GOOG) ahead of the company’s Q3 earnings report.
The stock is trading at a price-to-earnings (P/E) ratio of 23 – below the S&P 500 average. So it would be a good time for the firm to remind shareholders of its strengths, with a strong update.
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Background: AI expenses
Alphabet has been working hard to build artificial investment (AI) capabilities into its Google search products. And while it has had some success in this area, it’s a very expensive business.
Accordingly, both CEO Sundar Pichai and CFO Ruth Porat have warned of lower margins in Q3. The firm is looking to bring down its costs, but the effects aren’t forecast to show up yet.
This could well mean that profits come in lower than in 2023 – even if revenues are higher. This would be unlikely to lift the share price from its current levels.
I wouldn’t rule out a positive surprise though. I think it’s fair to say the stock currently reflects low expectations for Q3, so any unexpected news might be significant.
Google Cloud and YouTube
One place a positive surprise might come from is Google’s Cloud division. This part of the business has been growing well – Q2 featured 29% revenue growth and profits up almost 200%.
Things were different with YouTube though, where revenue growth underperformed the company as a whole. But the business still has a leading position in the US streaming industry.
Either could plausibly produce a strong performance and remind the market of Alphabet’s strength. It’s worth noting though, that the two together contribute less than 10% of total sales.
Neither is therefore going to offset the effect of higher costs in the core search business. But either could help justify some of the significant investments the company is making.
Legal challenges
The biggest challenge Alphabet is currently facing is regulatory. In August, a US judge ruled that Google acted illegally to maintain its monopoly status in the online search industry.
On top of this, another trial beginning last month accuses the firm of operating an illegal monopoly. This time it’s the company’s advertising technology business that’s the focus.
There’s a lot at stake for the company, with Google Services contributing 90% of overall sales. But the outcome is unclear and it’s not something Alphabet can control.
What the company can do is continue to run its operations as well as possible. And that’s what investors should be looking for evidence of in the upcoming report.
Investment uncertainty
Right now, Alphabet is facing a lot of uncertainty. Whether it’s the returns on AI spending, or the outcome of its latest court case, there’s a lot that’s difficult to forecast at the moment.
With a big company, it’s easy to underestimate these potential risks, especially with the stock at a low P/E multiple. But I think there are better opportunities for me right now.
