Alphabet (GOOG -0.09%) (GOOGL -0.09%) has had an impressive run so far this year, riding the rapid adoption of artificial intelligence (AI) and a broad-based recovery of tech stocks. Shares of the search giant are up 45% so far in 2023, roughly three times the 15% gains of the S&P 500. This is in stark contrast to last year, when the stock lost more than 39%.
The biggest catalyst lifting Alphabet this year was the company's better-than-expected financial results, which illustrated once and for all that the advertising market is on the road to recovery. This gave investors a much-needed boost of confidence that the broader macroeconomic headwinds casting a pall over Alphabet's performance might finally be easing.
What are the broader implications for investors who sat out Alphabet's current rally? Should they buy now in anticipation of additional gains or avoid the stock because of its recent run-up? Let's see what the evidence suggests.
Image source: Getty Images.
What caused Alphabet stock to plunge in the first place?
There's little question that in 2022, broader economic factors were the principal drivers of the market downturn. The combination of persistent inflation and the Federal Reserve's campaign of rising interest rates left most households -- and businesses, for that matter -- with very little discretionary income. This, in turn, caused a commensurate drop-off in consumer and business spending.
History shows that when faced with tough choices, one of the quickest ways for companies to reduce spending is in the area of marketing, which can be ramped up or dialed back with few overall consequences to the business.
That simple reality was on full display for Alphabet in 2022. Full-year revenue increased just 10%, a far cry from its 41% gains the year before. Some investors headed for the exits, ignoring the temporary nature of the situation. History shows that once an economic recovery begins, advertising spending resumes and ramps up just as quickly as it declined.
Even in the face of those macro headwinds, Google remained the dominant leader in worldwide search, with 92% of the market. This fuels the digital advertising that generates the lion's share of Alphabet's revenue, capturing 30% of worldwide digital ad spending, according to online marketing trade publication Digiday.
This illustrates that Alphabet's revenue will rebound when ad spending reverts to historical norms -- and the evidence suggests that this process has already begun. In the second quarter, Alphabet's revenue increased 13%, compared to a 3% increase in Q1. While there's still work to be done, it suggests the ad market is on the road to recovery -- along with Alphabet's stock.
What could drive Alphabet stock higher?
The ongoing rebound in the ad market aside, there are other catalysts that could fuel an ongoing rally for Alphabet stock.
The most obvious contributor is cloud computing. In the second quarter, Google Cloud was the third-largest cloud infrastructure provider worldwide, but controlled just 9% of the market, trailing Amazon Web Services with 30% and Microsoft Azure with 26%, according to a report by market analytics company Canalys.
Yet, even as economic conditions have weighed on cloud spending, Google Cloud remains the fastest-growing of the three, with revenue that grew 31% year over year, even as Azure and AWS grew 26% and 12%, respectively. The report noted that "Google Cloud's partner ecosystem continues to provide support in the development of its generative AI applications."
Furthermore, during Google's second-quarter conference call, Sundar Pichai said that 70% of generative AI start-ups are Google Cloud customers. If Alphabet continues to increase its cloud share more quickly than its competitors, this could drive future growth.
There's also Alphabet's ongoing AI development. Back in May, at the company's 2023 I/O developer conference, Google debuted a host of AI-fueled features and products, continuing its long track record of leveraging AI to propel its growth.
How to approach Alphabet stock now
Alphabet is currently selling for just 19 times trailing earnings, far cheaper than the price-to-earnings (P/E) ratio of 25 for the S&P 500. That's particularly reasonable considering that Alphabet is expected to return to double-digit revenue and earnings-per-share growth between now and 2024.
To recap: Alphabet has numerous growth drivers that could spark a long-term rally, which could last for months and even years. Experienced investors prepared to withstand some volatility should buy Alphabet or add to a position now, particularly in light of the company's strong history of growth and the enduring prospects ahead.
