3 reasons why Alphabet stock will not outperform the S&P 500 next year

"Big tech" stocks have lagged the broad S&P 500 index this year, and online advertising giant Alphabet is no exception. Its stock is down nearly 34% year-to-date compared to the S&P 500, which has erased about 16%. Here are 3 reasons why this underperformance in GOOG stock could persist into 2023.

On closer inspection, however, the question is whether improving economic conditions will mean a big rebound for the tech giant's stock. The road back to its all-time high closing price ($150.71 per share ) could be much longer than currently expected.

There are three factors, all of which will remain in play even after today's problems, such as inflation and slowing economic growth, are resolved. With that in mind, the stock (just under $100 per share today) may not be the opportunity to miss that some think it is.

These 3 factors could limit the future returns of Alphabet stock

Even after a prolonged pullback during the stock market downturn in 2022, Alphabet $GOOG+0.7%, $GOOGL+0.5% shares are up 481% over the past decade. This equates to an approximately 19.24% annualized return. Not too shabby.

Given the company's current size ($1.24 trillion market cap), few expect similar gains over the next decade. But it's not a sure bet that GOOG stock will outperform the overall market over the next decade, as three factors could limit future returns.

First, interest rates, which are undoubtedly related to the company's current headwinds. Inflation is at its highest level in decades. But the Federal Reserve, which sets the country's monetary policy, took another step at its last meeting in its attempt to curb these economic stresses by raising interest rates by three-quarters of a percentage point for the fourth time this year. "Without price stability, the economy doesn't work for anybody," Fed Chairman Jerome Powell said at a news conference on Wednesday, Nov. 2.

High inflation has led to high interest rates, which has affected economic growth and Alphabet's underlying performance. Still, even after inflation cools, interest rates won't necessarily return to near zero. That could limit the extent to which GOOG's earnings multiple (currently at 18.94 ) will expand again after the downturn. Investors are therefore now wondering whether, after a cycle of interest rate hikes around the world, markets are approaching a so-called pivot, i.e. a slowdown in the pace of such rapid tightening and a reversal in central bankers' rhetoric. Today, it's the Fed's turn again. US consumer price inflation has boosted the chances of a dovish move by the Fed. A rate hike at today's meeting is more than certain. The market is currently discounting a 50 basis point rate hike at tomorrow's FOMC meeting. Also of note will be the release of the dot-plot (published quarterly) in which members communicate their current expectations for interest rates.

Second, performance will be slowed by the maturation of Alphabet's core search advertising business. Certainly, growth in other segments, such as cloud computing, could outweigh this.

However, a third factor (increasing competition) may spoil the chances of that happening. High competition for market share between Alphabet and rivals like Amazon and Microsoft may limit future growth and swing to profitability of its cloud business.

Amazon Web Services (AWS), a profitable cloud platform online retailer that has established itself as the early leader in the cloud infrastructure market, is still ahead. Synergy Research Group estimates that Amazon's market share of the global cloud infrastructure market will reach 34 percent in the third quarter of 2022, still exceeding the combined market share of its two largest competitors, Microsoft Azure and Google Cloud.

Global spending on cloud infrastructure services reached $57 billion in Q3 2022, bringing the industry total to $217 billion over the past twelve months. As the chart above shows, Amazon, Microsoft and Google accounted for two-thirds of cloud infrastructure revenue in the three months to September 30, with the top eight providers controlling more than 80 percent of the market.

"It's a strong testament to the benefits of cloud computing that despite the two major barriers to growth, the global market still grew 24 percent from a year ago," said John Dinsdale, principal analyst at Synergy Research Group.

Cost-cutting efforts continue

TCI Fund Management, which owns more than $6 billion of Alphabet stock and has been a major shareholder since 2017, told Google parent Alphabet in a letter that it needs to aggressively cut costs.

https://twitter.com/_prashantnair/status/1592778272840224769

Activist hedge fund TCI Fund Management sent a letter to Alphabet CEO Sundar Pichai on Tuesday, Nov. 15. TCI said Alphabet's cost base "is too high and management must take aggressive action." The letter was signed by TCI CEO Christopher Hohn.

"(Alphabet) has too many employees and the cost per employee is too high," TCI wrote in the letter. "Management should post an Ebit margin target, substantially reduce losses in other bets, and increase share repurchases."

Alphabet did not immediately respond to a request for comment. However, CFO Ruth Porat said during Alphabet's third-quarter earnings call that "Alphabet's actions to slow the pace of hiring will become more apparent in 2023."

Moreover, it does not seem likely that Alphabet plans to give in to further TCI demands for cost reductions. The activist hedge fund may balk at the company's high average salaries, but as it competes with its big tech rivals for top talent, this may be another area where the potential for cost cutting is limited.

Itmay not be ready to trim the "Other Bets" division either. While offsetting losses from "Other Bets" may make Alphabet's operating performance look stronger, management is unlikely to trim this division for fear of losing another large, high-growth project.

Summary

Alphabet's earnings could bounce back by 2024 according to sell-side forecasts, but that may only give the stock a slight boost once the current storms pass. Looking further into the future, earnings growth may be limited by the maturation of the company's search advertising business and high competition affecting its cloud computing unit. Not to mention its streaming unit, as platforms like TikTok gain market share (and ad dollars) from YouTube.

Before buying GOOG stock after its recent surge, keep in mind that future returns may be much less stellar. While the stock may not reach new lows, it may be a slow and disappointing trip back to higher prices.

Source: Investor Place, Barrons, Yahoo Finacne, XTB, Statista, Time

DISCLAIMER: All information provided here is for informational purposes only and is in no way an investment recommendation. Always do your own analysis.