1 green flag for Alphabet in 2023 and 1 red flag

Shares of Alphabet (GOOG -0.03%) (GOOGL -0.09%) fell 9% before 10 a.m. Oct. 25 after the company posted its third-quarter earnings. Revenue rose 11%, beating estimates by $980 million and returning to double-digit growth.

However, the jump in sales was overshadowed by the disappointing performance of the Google Cloud business, which did not grow as much as expected. The company has invested heavily in the burgeoning artificial intelligence (AI) market, but seems to have fallen behind competitors Microsoft and Amazon.

Alphabet shares are up more than 130% over the past five years, and its dominance in digital advertising is a compelling reason to invest in it. However, a slowdown in cloud revenue could dampen its long-term prospects in AI.

So before you load up on Alphabet stock, here’s one green flag and one red flag for the company in 2023.

The green flag: Alphabet achieved a solid recovery in ad revenue

Alphabet was particularly hard hit by macroeconomic issues in 2022, with its share price plunging 39% in the 12 months. Spikes in inflation and interest rates have caused many companies to cut their budgets, with advertising being one of the first things to cut. More than 80% of Alphabet’s revenue comes from digital advertising, which meant its business was particularly vulnerable to last year’s economic downturn.

However, 2023 saw a resurgence of Alphabet’s advertising segments. In the second quarter, Google’s services revenue grew 5% year-over-year, with growth reaching nearly 11% in the third quarter.

The increase was largely driven by growth in Search and YouTube. These platforms bring together billions of users per day and have enabled Alphabet to achieve a leading 25% market share in digital advertising.

Digital advertising spending is projected to reach $680 billion this year. Meanwhile, Alphabet’s brands like YouTube, Android and Google’s many services provide the company with nearly endless advertising opportunities. Its success in the industry has increased its annual revenue by 107% over the past five years, with operating income rising by 130%.

Much of Alphabet’s business is still vulnerable to the economy, but its comeback this year illustrates why it’s critical to keep a long-term mindset and hang on in uncertain times. The company’s dominance in advertising is likely to continue to offer significant returns to patient investors.

The red flag: cloud revenue disappointed last quarter

Artificial intelligence has grown this year with an increasing number of businesses and consumers looking for ways to use the technology to increase efficiency. As a result, cloud companies are rushing to expand their AI services and capitalize on this market’s projected compound annual growth rate of 37% through 2030. Alphabet joined in by adding new generative AI tools to Google Cloud and gradually integrating the technology into its product composition.

Google Cloud holds an 11% market share in cloud computing, making it the third largest cloud platform in the world. However, it is significantly behind the top two, Amazon Web Services and Microsoft’s Azure. The artificial intelligence market is expanding rapidly, and Alphabet is finding it challenging to advance its cloud business.

In the third quarter, Google Cloud revenue came in at $8.4 billion, missing analysts’ expectations by about $230 million. In the same quarter, Microsoft’s Azure revenue rose 29% year over year, beating estimates of 26%.

Microsoft got a head start on AI with its 49% stake in ChatGPT developer OpenAI, making it one of the first companies to introduce AI upgrades to its services. As a result, Alphabet’s prospects in the cloud market are weakening, which could threaten its profit potential from AI.

Alphabet remains an attractive tech company with its dominance in digital advertising and the power of Google Search and YouTube among consumers. Meanwhile, its price-to-earnings ratio of 24 made it one of the best deals in tech.

However, its future in AI is uncertain. So if you’re specifically looking for AI stocks, it might be best to consider alternatives like Microsoft.

Suzanne Frey, CEO of Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, a subsidiary of Amazon, is a member of The Motley Fool’s board of directors. Dani Cook has no position in any of the stocks mentioned. The Motley Fool has positions and recommends Alphabet, Amazon and Microsoft. The Motley Fool has a disclosure policy.

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