By Anthony Di Pizio, The Motley Fool, Trades Of The Day, 2024-07-31
Alphabet (GOOG) (GOOGL) is the technology conglomerate behind Google, YouTube, autonomous driving company Waymo, and artificial intelligence (AI) developer DeepMind (to name just a few of its subsidiaries).
Google remains the dominant internet search engine globally, and it used that success to build other businesses like Google Cloud and Google Workspace (which includes Gmail and Google Docs). But as the window to the internet for over 20 years, Google Search is also a repository of some of the most valuable data in cyberspace, which gives Alphabet an incredible edge in the AI race.
Alphabet is already generating billions of dollars in revenue from AI specifically, and the best is probably yet to come. Its stock is very cheap based on one widely used valuation metric, and when investors look back on this moment in five years, they might wish they had bought it today.
Alphabet is weaving AI throughout its entire business
Google has a 91% global market share in the internet search industry, but it came under threat last year following the rapid adoption of OpenAI's ChatGPT. AI-powered chatbots can provide direct answers to almost any question, creating a more convenient experience compared to Google Search, which requires the user to sift through webpages to find the information they need.
It prompted Alphabet to launch its own family of AI models called Gemini, which power a new Google Search feature called AI Overviews. Overviews speed up the search experience by delivering text-based responses at the top of Google's traditional web results. They include reference links so the user can view the source of the information, and Alphabet says they are receiving more clicks than the links that appear in traditional search results. That could have positive implications for advertising revenue when AI Overviews roll out more broadly.
Gemini is also available in Google Workspace for an additional monthly subscription fee. It integrates into productivity applications like Google Docs, Sheets, Slides, and Gmail, allowing users to rapidly create content and speed up their workflows. One Workspace customer, Click Therapeutics, is using Gemini to analyze patient feedback to build digital treatment plans, and the use cases will likely expand further over time.
Google Cloud is another critical component of Alphabet's AI strategy. Like most top cloud providers, Google Cloud offers AI data center infrastructure fitted with chips from leading suppliers like Nvidia. However, Alphabet also designed its own chips in-house, and its new Trillium tensor processing unit (TPU) delivers 5 times more compute performance than the previous version.
Developers use that computing power to perform AI training and inferencing to deliver the most advanced AI models, so faster chips can translate into cost savings and higher-quality outcomes. Google Cloud also offers a library of ready-made large language models (LLMs), including Gemini, which developers can use to accelerate the creation of their applications.
Google Cloud just crossed a noteworthy milestone
Alphabet generated a record $84.7 billion in revenue during the second quarter of 2024 (ended June 30), a 14% increase from the year-ago period. Google Search remained the dominant part of the conglomerate, accounting for more than half of that revenue.
Google Cloud was the standout performer, though, because its sales grew by 29% to $10.3 billion. It was the first time the segment crossed the $10 billion mark, and AI played a key role in achieving that milestone. Alphabet said its AI infrastructure and solutions have already generated billions of dollars in revenue to date, with over 2 million developers currently using them.
Both of those numbers are likely to rise in the future as more businesses integrate the technology into their day-to-day operations.
Alphabet continues to carefully manage its costs to drive profitability. Its total operating expenses ticked up 8.6% during Q2, and since that was much slower than the pace of its revenue growth, more money flowed to the bottom line. As a result, the company's earnings per share soared 31% year over year to $1.89.
Capital expenditures are one thing investors are watching closely, because building AI infrastructure is incredibly expensive. Alphabet spent $13 billion on capital expenditures during Q2, and it expects to spend at least $12 billion per quarter for the rest of 2024. The company warned this could temporarily pressure its profit margins, but the long-term payoff from having more AI capacity could outweigh any short-term negatives.
Alphabet stock is cheap
Alphabet generated $6.97 in earnings per share over the last four quarters, and based on its stock price of $167.28 as of this writing, it trades at a price-to-earnings (P/E) ratio of 24. That is a 24.7% discount to the Nasdaq-100 index, which has a P/E ratio of 31.9, implying Alphabet is heavily undervalued compared to its big-tech peers.
Alphabet's P/E ratio is also the cheapest among every other company with a valuation of at least $2 trillion:
Microsoft, and Apple trade at an average P/E ratio of 45.2. That number is heavily skewed by Nvidia, so I'm not suggesting Alphabet stock will climb that high. However, it might be appropriate for the stock to rise 45% to trade in line with the average P/E ratio of Microsoft and Apple, which is 35.
After all, Alphabet's earnings growth of 31% during Q2 was substantially faster than what both Microsoft (8.9%) and Apple (13.5%) are forecast to deliver in their upcoming quarters. Plus, Alphabet might have an edge over both companies in the AI space, because they rely heavily on third-party developers like OpenAI for their AI software.
Simply put, besides the fact Alphabet is generating strong growth already with promising long-term potential thanks to AI, there is a clear case its stock should be trading much higher based on the valuations of some of its peers in the tech industry.
Therefore, when investors look back on this moment a few years from now, they might be glad they scooped up Alphabet shares at the current price.
— Anthony Di Pizio
Source: The Motley Fool
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