The period between 2020 and 2021 delivered astronomical growth for technology companies, as the economy adapted to a new world born from the COVID-19 pandemic.
Organizations needed more software and more devices to facilitate remote work, and consumers in general were spending more time in front of screens which led to a boom in the digital advertising sector. Those tailwinds fell right into the lap of Google parent Alphabet (GOOGL 4.36%) (GOOG 4.42%).
But that picture is very different now. The U.S. economy began to wobble in 2022 as inflation and interest rates spiked, caused in-part by a return to normal societal conditions. The tech sector alone was responsible for 154,000 job cuts last year as it raced to adjust to this new reality.
With the economic outlook for 2023 still uncertain, Alphabet today announced layoffs of its own, cutting 12,000 jobs across the organization. CEO Sundar Pichai said this would help the company focus on its priority areas, but what does it mean for the stock?
Cost cuts could improve Alphabet’s sagging earnings
Alphabet’s stock price has declined by 35% from its all-time high amid the broader sell-off in the technology sector. It’s certainly not alone, but the company has experienced a decline in profitability in recent quarters which can often sap the confidence of investors.
Alphabet went on a hiring spree during the pandemic. It had 118,899 employees at the end of 2019, and that ballooned to 156,500 by the end of 2021. It continued hiring in 2022 even in the face of a weakening economic outlook, ending September with a headcount of 186,799.
But while the company continued to hire, its revenue began to slow. Total revenue increased by just 6% year over year in the third quarter of 2022 (ended Sept. 30) compared to 41% in the year-ago period. What happens when costs soar but revenue growth slows to a crawl? Profits begin to evaporate.
After three consecutive quarters of declining earnings on a sequential basis, Alphabet’s move to trim costs is a prudent one. While job cuts are never pleasant, they’re a necessity when the economy simply isn’t performing as well as it was when those jobs were added.
Google might be facing its first real threat, well, ever
Google absolutely dominates the internet search industry. It has a global market share of 92% globally, and its nearest threat is Microsoft (MSFT 2.80%) Bing at just 3%. But no company is immune to disruption, not even innovative global tech giants.
Microsoft might be all set to invest a further $10 billion in OpenAI, the company responsible for the artificial intelligence (AI)-powered ChatGPT (following a $1 billion investment in 2019). It’s a revolutionary language model that can hold a conversation with users, answering seemingly any query instantly and with a high degree of detail. It has captivated tech enthusiasts, and it has the potential to be a real thorn in Google’s side.
AI models like ChatGPT could reimagine the way people use the internet to acquire skills and information, and Alphabet’s closest competitor getting the jump on this technology might create a problem. See, where Google can give you the resources to learn how to write poetry or write code, ChatGPT can actually perform those actions for you (albeit at a relatively basic level right now).
That’s why, as part of Alphabet’s recent job cuts, Sundar Pichai named AI as a core focus area. The good news is that Google will likely be the dominant player in search by a wide margin for several years to come, so it has time to mount a response to this potential threat. By making the business more efficient, it should have more capital to invest in the project over time.
Alphabet stock looks like a great buy at the current price
For investors, this stock market environment has become more about dollars and cents than a company’s potential. Thanks to the 35% decline in Alphabet stock, it now trades at a price to earnings (P/E) multiple of just 19.3. That’s near the cheapest level since 2014.
That’s also 21% cheaper than the Nasdaq-100 technology index which trades at a P/E multiple of 24.7. To put it simply, Alphabet is trading at an attractive discount to the rest of its peers in the tech sector as a whole.
Beyond the exciting AI battle that’s heating up, Alphabet investors have plenty to look forward to in 2023. Its world-leading video streaming platform, YouTube, could be set to experience a new phase of growth thanks to Shorts, its short-form video concept designed to compete with ByteDance’s TikTok. The format’s ability to attract young users and keep them engaged could result in a plethora of new opportunities to generate revenue this year and beyond.
Job cuts are an unfortunate part of running a global organization, but they can be essential for maintaining the health of the business. Alphabet should come out of this difficult period a much stronger company, and investors might want to take advantage of its discounted stock price right now.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet and Microsoft. The Motley Fool has a disclosure policy.