Alphabet Inc, the parent of Google, is set to report its latest quarterly earnings on Thursday, February 2, after the closing bell on Wall Street, alongside its tech compatriots, Apple and Amazon.com. With the US and global economy heading towards a downturn this year, tech earnings are facing a cyclical slowdown. Rival Microsoft has already issued a gloomy guidance, but could Alphabet be in even bigger trouble given its overreliance on ad sales for revenue?

Tech firms hit by hard times

It's fair to say that the boom times are over for the tech sector. After two years of exponential growth, tech stocks had a rough ride in 2022 and despite a mini rally so far this year, the outlook hasn’t improved. If anything, 2023 could get a lot worse for the tech industry. But it could also get better. The huge uncertainty around the outlook where the odds of a deep recession and soft landing are fluctuating day-to-day is one explanation as to why there have been so many bear market rallies during this downtrend.

Alphabet’s earnings call is unlikely to clear the fog in any way, but it should shed some light on the company’s resiliency during this particular economic slowdown. In previous downturns, revenue growth dipped only mildly and was quick to bounce back. The hit from the first pandemic lockdown was much more significant, but it was swiftly followed by the boost from pent-up demand.

Revenue fears from slowdown

But there are worries that it could be different this time. The problem of high inflation and high interest rates is a global phenomenon and so businesses internationally could be cutting their ad spending, not just in the United States. Alphabet’s cloud business – Google Cloud Platform – has also entered a challenging period, as has been the case with Microsoft’s Azure platform.

But Google Cloud is in a more difficult situation as the unit has yet to turn a profit. A global recession could delay the timeframe in which the business becomes profitable if revenue growth targets cannot be met. Alphabet has a number of other unprofitable ventures, which all fall under its ‘Other Bets’ division, including Waymo – the autonomous driving unit that has not been spared from the recent announcement of job cuts.

The company decided to join the big tech jobs cull last week by slashing its headcount by 12,000. The move underscores the general problem within the tech sector where many firms grew too rapidly during the post-pandemic reopening boom and are now finding themselves overstaffed and in need to reduce expenses as their earnings prospects dwindle.

Will ads segment hold up?

Whilst this may have provided an immediate lift to the stock price as the layoffs should be positive for net income over the next few quarters, earnings per share (EPS) in the last quarter of 2022 likely suffered further. The company is expected to report a fourth straight quarter of year-over-year drop in EPS of 22.5%, earning $1.19 per share versus $1.06 in the prior quarter, according to Refinitiv IBES.

Advertising revenue is forecast to have declined for the first time since Q2 2020, falling by 0.9% to $60.68 billion, while total revenue is expected at $76.67 billion – a rise of just 1.8% from the same quarter a year ago.

If ad revenue beats the estimates, that could be taken as a sign that Alphabet’s core Google Ads business is faring better than expected during the slowdown and that spending on digital advertising is becoming less cyclical. A positive surprise is also possible from the cloud segment. Google has been investing heavily in its cloud infrastructure and expanding its reach to more and more countries. At the same time, Google Cloud has been scaling back some of its less profitable offerings.

Microsoft poses an AI threat

However, investors will want to see that Alphabet is doing more to stop the cash bleed in all loss-making parts of the business, as well as hear about how it plans to compete with Microsoft’s foray into Artificial Intelligence (AI). Alphabet reportedly has its own answer to ChatGPT – the AI system that Microsoft has partnered with – called LaMDA. But it’s unclear if LaMDA works just as well or whether Alphabet sees this as enough of a threat to integrate AI into Google Search the same way Microsoft intends to add ChatGPT to its Bing search engine.

Finally, analysts will be paying attention to Alphabet’s other services, particularly YouTube and how well both advertising and paid subscriptions are holding up for the popular music and TV streaming service.

Earnings growth is key for the stock

If revenue growth does not decelerate as fast as anticipated, at least in some parts of the business like the cloud unit, the share price could move higher after the earnings results. The main target on the upside is the $100 level, which is the January top and not far from the 50% Fibonacci retracement of the March 2020-February 2022 uptrend. After which, the 200-day moving average would come into scope. In case of a sustained rebound, the August 2022 peak of $122.43 would be important for the bulls.

However, should the company fail to ease concerns about slowing revenue growth, whether through its actual results or guidance for the next quarter, the stock could tumble towards the November trough of $83.34. Breaking this low would clear the path for the 78.6% Fibonacci of $72.08.

Relatively attractive

The share price is currently trading at a discount to the recommended median price target of $123.70. Analysts are firmly maintaining their ‘buy’ recommendation for the stock despite some clouds forming over the horizon. One reason why Alphabet remains relatively attractive is that it has a lower price/earnings (P/E) ratio than all its main competitors as well as the Nasdaq average. Its valuation also looks less bloated when comparing the forward 12-month multiples.

However, Alphabet still has a number of pending antitrust investigations. Only in the past week, the US Justice Department sued Google for abusing its dominance in the online ad market by forcing advertisers to use its own ad technology. Fears are growing that regulators will eventually push for the breakup of Google by spinning off the ad business.

Moreover, investors are still not satisfied with the pace at which Alphabet is diversifying its revenue streams and weaning itself off from its online ads dependency. Hence, whilst there are a number of positives that could be supportive of the stock during this downtrend, the many risks Alphabet faces are likely to keep any gains in check.