Investor excitement for artificial intelligence (AI) has reached a fever pitch. Most stocks associated with AI are soaring, with Nvidia recently becoming the largest company in the world by market capitalization. Another example is Palantir, which is up a whopping 283% year to date due to the rapid adoption of its AI tools across the United States government and big business.
While it might be exciting to chase these fast-running AI stocks, smart investors know it is a dangerous game. That is why hedge fund managers such as Bill Ackman and Charlie Munger protege Li Lu own large stakes in Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) to play the AI boom. The big tech stock is crushing it with new AI innovations, leading to strong revenue and earnings growth. And yet, the stock is underperforming the S&P 500 in 2024.
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Should you add Alphabet stock to your portfolio?
Today, many investors know about OpenAI and its ChatGPT products. But did you know that its underlying technology was invented by Alphabet? That’s right, Alphabet — parent company of Google and YouTube — invented the transformer model back in 2017. Transformers are a type of neural network that can learn by ingesting data, which is why they are perfect for training AI.
In 2024, Alphabet has applied transformer AI innovation to dozens of products. This includes circle-to-search, AI photo editing, the Gemini conversational chatbot, and Google Search AI summaries. Unlike AI start-ups, Google already has existing users it can automatically upgrade to these new AI innovations, improving its customer value proposition and further separating itself from the technology pack. For context on Alphabet’s massive scale, last quarter its seventh product (Google Maps) hit 2 billion active users.
All seven of Alphabet’s products with 2 billion users now have its Gemini AI models embedded as a feature. From Google Docs to Gmail to Google Search itself, Alphabet is bringing cutting-edge AI tools to billions of people around the world.
Alphabet’s products are getting a major upgrade with all these new AI features. Fast growth in AI can present a double-edged sword, though. Due to the computing intensity of AI language models, training and querying these AI features can require tons of spending on computer chips, energy, and data centers. Apply it to hundreds of millions or billions of users and the computing bill can add up fast.
Start-ups in the AI space are dealing with this problem. All of them have good usage growth but are burning a boatload of cash. Not Alphabet. Alphabet has many ways to implement these AI tools to generate more revenue. First, it is applying generative AI techniques to its new advertising tool, Performance Max, which quickly lets brands of all sizes spin up advertisements across Alphabet’s properties like Google Search or YouTube.
Second, it can monetize new AI responses directly on Google Search, with the company already experimenting with sponsored listings for its new AI summary feature. Third, it can outsource these AI tools through the Google Cloud division, which is one of the leading cloud computing companies in the world.
This is leading to fast revenue growth for Alphabet even at its immense scale. Last quarter, Google Cloud revenue grew 35% year over year to $11.4 billion. Google Search grew 12% year over year to $49 billion. YouTube advertising grew 12% year over year to $8.9 billion. In total, Alphabet’s revenue grew 15% last quarter to an astounding $88 billion. And, despite the massive computing costs needed to maintain all these AI tools, operating margin expanded to 32%.
Even though Alphabet is crushing it in AI, the stock is only up 23% this year. Other AI-themed stocks like Nvidia and Palantir are up 100% and trade at nosebleed earnings ratios.
Alphabet’s stock looks reasonably cheap at today’s price. It has a price-to-earnings ratio (P/E) of 23, which is well below the S&P 500 index average of 30 right now. For a company with a long track record of double-digit revenue and earnings growth, investors may be underrating Alphabet stock at the moment. Don’t forget its heavy share repurchase program, which brings down its total outstanding shares and further boosts earnings per share (EPS) every year. EPS growth is the lifeblood of stock price appreciation over the long haul.
If you believe Alphabet can further expand its lead in AI over the next decade, you’ll do well if you buy from here and hold for the long term.
When our analyst team has a stock tip, it can pay to listen. After all, Stock Advisor’s total average return is 881% — a market-crushing outperformance compared to 173% for the S&P 500.*
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Brett Schafer has positions in Alphabet. The Motley Fool has positions in and recommends Alphabet, Nvidia, and Palantir Technologies. The Motley Fool has a disclosure policy.
1 Magnificent AI Stock Smart Investors Are Adding to Their Portfolios (Hint: It’s Not Palantir) was originally published by The Motley Fool
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