This FAANG stock is down 35%. Buying it could be a stroke of genius

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This article originally appeared on All figures are in US dollars unless otherwise specified.

This market takes no prisoners. Whether you own shares of a new public company or one of the world’s most dominant technology companies, such as Alphabet (NASDAQ:GOOG) (NASDAQ:GOOG), it has been a difficult year. Specifically, Alphabet is down 35% from its peak, its biggest drop since the Great Recession (2007-2008).

But it’s not just a question of the market. Companies that advertise to make money, like Alphabet, are signaling economic turbulence on the horizon and bracing for a tougher operating environment. It might sound cliché, but leaning into fear and buying Alphabet could be a decision you brag about to your friends when things finally turn around. Here’s why.

Advertising becomes dangerous waters

Alphabet makes most of its money by selling advertisements on its two most popular internet platforms, Google Search and YouTube. Traffic is an essential part of it. The more eyeballs you have, the more you can charge for your ads. However, the total money companies spend on ads, which you can think of as a piece of cake, can vary in size. Businesses can advertise more when the economy is doing well and potential customers are spending more. On the other hand, advertising budgets can shrink when the economy is doing badly and people aren’t spending as much.

The US economy is already slowing down. Gross domestic product (GDP) has been negative for the past two quarters. Some already see it as a recession, but the worst may not be over. The Federal Open Markets Committee (FOMC), which sets the federal funds rate, the benchmark interest rate that determines what the rest of the economy can borrow from, is rapidly raising rates to combat high inflation.

Charts showing the US inflation rate and federal funds rate rising since the start of 2020, and quarter-over-quarter real GDP rising and then stabilizing.

US Inflation Rate Data by YCharts

It affects the economy. You may notice that your local bank’s mortgage rates have skyrocketed. Businesses that borrow money now have to pay higher interest on their loans. Rising rates make borrowing more expensive and reduce personal and business spending. This lower economic activity means advertising budgets are likely down. That piece of the pie that represents ad spend can get smaller.

Broken action, not broken business

You can see this playing out in Alphabet’s revenue growth over the past year, which has slowed significantly. Going from 40% year-over-year growth to 12% growth in four quarters seems like a pretty strong brake. But it’s critical to understand the context behind this and ask: Is it because Alphabet isn’t charging eyeballs for its ads, or are companies spending on advertising declining?

Chart showing Alphabet's quarterly year-over-year revenue growth down since late 2021.

GOOG Earnings Data (Quarterly YoY Growth) by YCharts

Based on the above economic circumstances, the cake becomes smaller. You can check ad agency landscapes and see similar growth slumps. Roku, for example, guided revenue growth of 35% for the full year 2022 in the first quarter. But he completely withdrew his full-year revenue growth forecast. just a quarter later due to economic concerns.

On the other hand, Alphabet’s two main platforms (Google and YouTube) remain the main traffic generators. A report for the month of August from Semrush named Google and YouTube as the two best sites on the Internet, registering more than 23 billion visits in August. was third with just 5.5 billion visits, showing just how big the gap is between Alphabet and the rest of the domain. Investors can be reasonably confident that Alphabet’s advertising revenue will recover once the economy improves, as its websites remain the dominant Internet destinations where brands prioritize their advertising budgets.

Take advantage of the sale

The stock’s decline remains a buying opportunity for long-term investors. Alphabet is now trading at its lowest price/earnings (P/E) ratio in a decade and is well below its median P/E of 27. From a price/sales (P/S) perspective, the stock only got cheaper during the COVID-19 crash of 2020.

Charts showing Alphabet's PE and PS ratios falling in 2022.

GOOG PE Ratio data by YCharts

Of course, growth may temporarily slow in this lackluster economic environment. Yet Alphabet remains a dominant company with a fortress-like balance sheet that includes $125 billion in cash against just $12 billion in debt. It appears that this decline is driven by the market and the economy and not by Alphabet’s fundamentals, making this a possible buying moment for patient investors.

This article originally appeared on All figures are in US dollars unless otherwise specified.

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