AI Titan Alphabet's Shares Soaring. Yet, Is It a Wise Investment Decision?
Despite Halloween being over, I can't help but notice the eerie red tinge in the financial landscape. I'm not referring to ghosts or goblins, but rather the turbulent stock market, specifically the sell-offs that have occurred.
The third-quarter earnings season is here, and the upcoming presidential election is causing a flurry of uncertainty. This uncertainty is manifesting itself in the form of market fluctuations, which I'm not a fan of.
However, one stock that's been holding its ground fairly well is the tech giant and "Magnificent Seven" member, Alphabet (GOOGL -1.11%) (GOOG -1.16%). Following an impressive earnings report on Oct. 29, Alphabet's shares saw a boost of up to 10%.
In this article, I'm going to delve into the key aspects of Alphabet's third-quarter earnings and discuss whether this could be a good time to invest.
What's driving Alphabet's stock?
For the quarter ending Sept. 30, Alphabet reported a revenue of $88.3 billion, an 16% year-over-year increase in a constant currency basis. Even more impressive is the 32% year-over-year growth in Alphabet's operating income, which now stands at $28.5 billion. The company also generated $17.6 billion in free cash flow.
Alphabet's main revenue and profit generators are its enormous advertising business, underpinned by Google's search tool and YouTube's video-sharing platform. Sales from both Google and YouTube increased 12% year-over-year during the third quarter. It's worth noting that overall advertising spending has increased across social media platforms due to the presidential election.
Over the past few months, Alphabet has also made considerable progress in subscription services and cloud computing. Alphabet's Google Cloud Platform (GCP) saw a 35% year-over-year increase in sales, making it Alphabet's fastest-growing business.
Alphabet credits Google Cloud's growth to advancements in generative AI. In the words of Alphabet CEO Sundar Pichai, "Our technology leadership and AI portfolio are helping us attract new customers, win larger deals, and drive 30% deeper product adoption with existing customers."
Alphabet is integrating AI into its entire suite of services, from search to video content, productivity tools, cybersecurity, and beyond. This approach is strengthening Alphabet's position as a platform, making it more attractive for customers who are increasingly using AI-powered products and services.
Analyzing Alphabet's valuation
Below is a comparison chart of Alphabet's and Microsoft's forward price-to-earnings ratios (P/E). I excluded Amazon from this analysis as its earnings and profitability are more volatile than those of Microsoft or Alphabet, and I don't see much overlap in competition between Amazon and Alphabet beyond cloud computing.
It's clear that investors are assigning a higher value to Microsoft compared to Alphabet. Alphabet's forward P/E of 21.4 is even lower than the S&P 500's average estimate of 23, which suggests that investors believe Alphabet's short-term returns are less attractive than the broader market.
However, considering Alphabet's current growth and its rising position in the AI landscape, these valuation discounts may seem unjustified. There are reasons why these discrepancies in valuation multiples could make sense.
Factors to consider
Although Google and YouTube remain popular platforms, Alphabet is not without competition.
Meta Platforms boasts 3.3 billion daily active users across Instagram, Facebook, and WhatsApp. These platforms present attractive alternatives for advertisers, and the competition is stiff.
TikTok has also gained popularity in recent years, especially among younger demographics.
Moreover, ChatGPT recently launched a new search tool that could potentially pose a threat to Alphabet in the long run. If ChatGPT manages to lure users away from Google, it could negatively impact Alphabet's advertising value proposition. Plus, considering Microsoft has an equity stake in ChatGPT, the company could potentially benefit from its own search functionality, Bing, if users begin to abandon Google.
Although Alphabet stock might appear to be a bargain, there are several unknowns surrounding its long-term potential. This uncertainty is contributing to Alphabet stock's discounted valuation compared to its peers.
Do you think you should invest in Alphabet? On the one hand, the company is showing promising advancements in its core product offerings to support its investment in AI. On the other hand, the competitive landscape is intensifying, particularly in its biggest sources of sales and profits.
For these reasons, I'd suggest being cautious with Alphabet for now but keep a close eye on it as the AI narrative unfolds.
Given the uncertainty surrounding the upcoming presidential election and its impact on the stock market, some investors might be hesitant to put their money into the market. However, if one is looking for potential growth opportunities, Alphabet's impressive third-quarter earnings report and advancements in generative AI could be compelling reasons to consider investing in the tech giant. Despite the high valuation dispute with its competitors like Microsoft, Alphabet's promising growth in its main revenue generator, advertising, and its rising position in the AI landscape indicate that it might be worth considering as a long-term investment.
