Why Alphabet's earnings disappointment is no reason to panic

Investors need to put the earnings report into perspective.

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This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Earnings disappointments tend to bring not only stock selling but also longer-term doubts about a stock. And investors learned from Alphabet's (NASDAQ: GOOGL) (NASDAQ: GOOG) recent third-quarter earnings report that even mega caps are not immune from such negative sentiment.

Nonetheless, doubts about stocks like Alphabet should serve as a reminder to look at a company more closely. Do the concerns about Alphabet mean investors should close positions or buy shares at the new, lower price? 

Alphabet's third-quarter earnings

Admittedly, this earnings report is one both shareholders and the company will want to forget. Third-quarter revenue of $69.1 billion fell slightly short of the $70.6 billion forecast by analysts. Also, the $13.9 billion net income, or $1.06 per share, came in well below the $1.25 per share consensus.

Additionally, both YouTube and the Google Network experienced a revenue decline of around 2% over the last 12 months. Amid these swoons, overall ad revenue rose by 3%, and company revenue increased by 6% over the same period.

Still, this lags behind the 41% yearly revenue growth reported in the third quarter of 2021. Not surprisingly, the stock price dropped following the news. The latest decline means the stock has fallen by about 30% over the last 12 months.

What to make of the report

Alphabet described the business climate as "uncertain" on the earnings call and, indeed, no investor should characterize the results as good news.

However, the situation also calls for some perspective. First, ad-market competitors such as Meta Platforms have experienced the same sluggishness in the ad market. This confirms the uncertainty Alphabet mentioned on the earnings call.

Moreover, Alphabet recognized years ago that it needed to develop sources of revenue outside of advertising. To that end, it bought numerous companies in various parts of tech. This includes Calico and Verily Life Sciences in the biotech fields, autonomous car company Waymo, artificial intelligence company DeepMind, and numerous others.

Admittedly, investors may be frustrated that the company does not generally release financials for these segments. One might also think the diversification away from advertising has moved too slowly. In the third quarter of 2015, advertising claimed 90% of Alphabet's revenue. By the third quarter of 2022, it had only fallen to 79%.

Still, one of the few non-ad segments it reports, Google Cloud, made up 10% of company revenue in Q3. Additionally, Google Cloud revenue grew 38% year over year, so that portion will likely continue to increase.

Don't forget a key fundamental

Investors also need to remember Alphabet's ace in the hole: liquidity. At the end of Q3, the company reported more than $116 billion in cash, cash equivalents, and marketable securities.

That has fallen from about $140 billion at the end of last year. Still, it leaves the company with considerable resources to find new revenue resources without having to incur rising borrowing costs.

Also, Alphabet has generated $44 billion in free cash flow in the first nine months of the year. That slightly decreased from the $48 billion in the first three quarters of 2021. Nonetheless, it leaves Alphabet in a strong cash position that can ensure the company's future.

The state of Alphabet

The third-quarter earnings report does little to change Alphabet's value proposition. Admittedly, headwinds in the digital ad market have finally caught up with Google. However, the slowing growth likely speaks to the economic cycle more than Alphabet. That leaves room for recovery as conditions improve.

Moreover, the success of Google Cloud has reduced Alphabet's dependence on ads. Alphabet's tech businesses, massive liquidity position, and free cash flow could further diversify revenue sources over time. Thus, investors probably want to look at this report as a buying opportunity for the communications stock rather than a cause for panic.

This article was originally published on Fool.com. All figures quoted in US dollars unless otherwise stated.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Will Healy has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Alphabet (A shares), Alphabet (C shares), and Meta Platforms, Inc. The Motley Fool Australia has recommended Alphabet (A shares), Alphabet (C shares), and Meta Platforms, Inc. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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