Four tech stocks to consider as the giant's results disappoint

They say bad things come in threes. For this tech giant, the unholy trinity comprises rising interest rates, a slowing economy, and fewer advertising dollars being spent.

Revenue growth has slowed sharply from a year earlier amid plummeting online ad spend, down from 41% to just 6%. Aside from the depths of the COVID-19 pandemic, the period just gone has been the weakest period of growth since 2013.

The results do not bode well for the rest of the US Big Tech earnings due out through the rest of the season – particularly those that derive significant revenue from digital ad spend.

Of course, I'm speaking of tech monolith Alphabet (NASDAQ: GOOG). I reached out to Stephen Arnold, CIO at Aoris Investment Management, for his take on the results.

Perhaps more interestingly, Arnold provided valuable insights into the tech names he does like and which Aoris currently hold, as well as how he is viewing the tech sector over the coming 12 months. Make sure to read all the way to the bottom to get the insights. 

Alphabet (NYSE: GOOG) FY22 Q3 key results

Please note the 'expected' numbers below are consensus forecasts from Refinitiv and StreetAccount

• Earnings per share (EPS): US$1.06 vs. US$1.25 expected
• Profit: US$13.9 billion (down 27% year on year) vs. US$16.9 billion expected
• Revenue: US$69.09 billion (up 6% year on year) vs. US$70.58 billion expected
• YouTube advertising revenue: US$7.07 billion vs US$7.42 billion
• Search ad sales: US$39.5 billion (up 4% year on year)
• Google Cloud revenue: US$6.9 billion vs US$6.69 billion
• Traffic acquisition costs (TAC): US$11.83 vs US$12.38

Note: This interview took place on Wednesday 26 October. 

What was the key takeaway from this result?

The key takeaway for me is expense growth growing a lot faster than revenue, and the company going forward is going to have to pivot and pull the lever on expense growth to better balance revenue and expenses.

The stock was down almost 7% after hours. In your view, was it an overreaction, an under reaction or appropriate?

I think it's appropriate. I can see that on the revenue and expense line, how the cadence of the business, the trajectory of the business, is perhaps falling short people's expectations. And so we wouldn't take issue with the way the market has responded.

Were there any major surprises in this result that you think investors should be aware of?

One number that doesn't come through the P&L is the headcount growth, which is up 24% year over year. So basically, one in four people at Google wasn't there 12 months ago, which is quite remarkable. They added 36,000 people in the last 12 months, and that's an area where I think management will be pulling the handbrake hard as the headcount growth and commensurately, the expense growth, is running much faster than the revenue growth.

It'll be really interesting to get some transparency into what parts of the business the headcount has grown fastest. What buckets account for that 36,000 increase? I'm sure that the cloud side is a reasonable part of it, but where else is headcount growing?

As competition for talent starts to ease in the industry in which Alphabet operates, it might be that fewer people are leaving, so that you don't have to hire to replace the departures. Again, we only see the net result; we don't see the ins and outs, but that might be something that's at least playing a part.

The other interesting observation is the [line item] 'Other Bets', about which the company provides very little detail [and which includes Google's highly secretive idea generation arm called Google X]. The operating loss increased again there, despite overall profit pressures on the total business. So that went from a loss of US$1.3 billion to a loss of US$1.6 billion.

We'd like a lot more transparency than the company provides on where those losses are being incurred and what plans the company has, if any, to get better commercial outcomes from the significant resources that go into that Other Bets part of the business.

Would you buy, hold or sell Alphabet on the back of these results?

Alphabet is not a business that Aoris currently owns, and it is not a business that we have owned in the past. 

There are many parts of the business I think are admirable. All of the services that go under the name Google that we all use, I think are very valuable. And the search business that goes around that.

The reservations that we have are twofold. One is the aforementioned 'Other Bets'. Is this good use of shareholder capital? And number two is transparency. As shareholders, do we feel like we're being told what we think that we should, in order to make a good judgement about the business? Does a company communicate with the outside world in ways that makes us feel like they want us to understand? 

So those are two areas that we've struggled: the losses in 'Other Bets', and the transparency and quality of communication that we get as prospective shareholders.

What’s your outlook on Alphabet and its sector over FY23? Are there any risks to this company and its sector that investors should be aware of?

We own Microsoft (NASDAQ: MSFT), but we also own a banking software company called Jack Henry (NASDAQ: JKHY). We own a maker of connectors and census called Amphenol (NASDAQ: APH). And we own Accenture (NASDAQ: ACN), which is an IT outsourcing consulting business. So within the broadly defined technology ecosystem we own a few businesses. Within the large, popularly defined tech businesses, Microsoft is the name that we own.

I think this will be a year of discrimination where individual businesses will behave very, very differently in ways that perhaps weren't a feature through 2020 and parts of 2021. 

I think the stronger businesses will pull away, perhaps the loss-making businesses will find that it's harder to raise capital to continue operating. Your third and fourth players, perhaps will struggle.

We customers, in uncertain times, tend to go with more established, stronger names. And there'll be parts of the market that are becoming more competitive, streaming media services perhaps being one of many examples. So I think the performance of individual businesses will be widespread in ways that weren't a feature of the tech sector two years ago.