Looking at the headlines out there you would think artificial intelligence (AI) is all anyone seems to care about on Wall Street these days. Nvidia, which designs semiconductor chips and processors integral to the AI sector, briefly hit a market cap of $1 trillion mostly because of AI-related news about the company and its stock is trading up about 165% this year. It seems like every technology company these days is pivoting to new artificial intelligence (AI) products for their customers to take advantage of the heightened interest.
One of the leaders in AI is Alphabet (GOOG -1.33%) (GOOGL -1.33%), which this year released dozens of additional AI-powered tools across its Google Search, cloud, and workplace software services. Investors -- at least those with AI fever -- took notice and have sent Alphabet's share prices up close to 40% this year, beating several market indexes by a significant margin so far in 2023.
Should Alphabet investors consider cashing in on this AI-influenced bull run by selling some shares? Or will they be better off holding on to the stock because it has further potential to deliver outperformance? What about those considering buying the stock now?
Earnings are still driven by search
AI is being incorporated into numerous sectors, some more established than others. Language-based AI products such as Google's Bard chatbot are still in their infancy and are irrelevant to Alphabet's financials today. The majority of its earnings (58%) still come from its original business, Google Search advertising. Search advertising is also likely an even larger percentage of the company's bottom-line earnings. In the near term, Alphabet's earnings are going to be driven by the continued growth of this division. Profits aren't going to be materially affected if a few million people start using Google Bard as a chatbot companion.
Of course, Alphabet has been investing in AI capabilities for Google Search for many years now. Search results can now incorporate AI-generated snippets from articles, direct links to a point in a YouTube video that answers a query, and specific locations on Google Maps. All these AI capabilities further enhance Google's value proposition to its users while also creating economies of scale and barriers to entry that few companies, if any, can compete with.
Google Bard and these other chatbot AI tools can further improve the customer value proposition of Google's services, but it should be treated no differently than any other enhancement Google has made over the years that make it easier for someone to access the world's information. At the end of the day, revenue will be driven by how many search advertisements can be served up to these users, regardless of how they are making these queries.
Growth will come from YouTube, Cloud, and Waymo
Since the business is so large, investors shouldn't expect Google Search to grow much quicker than the entire digital advertising market. There are only so many dollars advertisers have in their budgets for search.
But Alphabet has a few other tricks up its sleeve that should keep revenue growing at a double-digit rate this decade. First is the continued growth of YouTube. YouTube is the dominant video platform on smartphones, tablets, and internet-connected TVs (CTVs) with over 2 billion monthly active users. The division "only" generated $7 billion in advertising revenue last quarter -- under 10% of Alphabet's consolidated revenue -- but still has a ton of room to run. Advertising dollars are only just starting to switch from traditional TV outlets to CTVs. As these budgets transition to where the eyeballs now are (streaming video), YouTube's advertising revenue should get larger from here as it's the most popular streaming channel in the United States. TV advertising is around $67 billion a year just in the United States, for reference. Add in the rest of the world and YouTube usage across smartphones and other computing devices and I don't think it is unrealistic to expect the division to hit $100 billion in annual advertising revenue by the end of this decade.
The second growth driver is Google Cloud, Alphabet's cloud infrastructure division that should benefit from the continued transition of IT services to the cloud as well as the AI boom. Virtually every industry could use AI capabilities to create efficiencies or enhance the customer experience, but few have the technological expertise. Google Cloud is a way for Alphabet to sell its AI expertise to third parties and make a boatload of revenue in the process. Last quarter, Google Cloud hit $7.5 billion in revenue, or a $30 billion annual run rate. Like with YouTube, it wouldn't be surprising to see this division hit over $100 billion in annual revenue by 2030.
Lastly, Alphabet is the leading self-driving company with its Waymo subsidiary. The company is doing over 10,000 daily rides in its three pilot cities (San Francisco, Los Angeles, and Phoenix) and wants to 10x its ridership rate by next summer. It will be irrelevant to Alphabet's financials for at least the next five years but is showing a ton of promise and could end up being a significant growth driver if it keeps up this impressive trajectory.
Why you shouldn't sell any shares (yet)
As of this writing, Alphabet shares trade at a forward price-to-earnings ratio (P/E) of approximately 23. This is much higher than the P/E of 16 it traded at earlier this year but still below the S&P 500's average of around 25 right now.
With a dominant business in Google Search and so many growth avenues, Alphabet is poised to grow revenue faster than the average publicly traded business this decade. The stock is still trading at a discount to the market average even after this huge bull run. Combine these two factors and you have a recipe for long-term market outperformance.
It might be prudent to sell or trim your Alphabet shares if its P/E gets well above the market average. But there's no reason to sell your shares just because the stock popped 40% to start 2023. Long-term winners -- by definition -- are stocks you hold for the long term, not just a few quarters.