The rise of artificial intelligence (AI) applications and large language model chatbots this year led some investors to doubt the investment thesis for one of the market's most stable companies. These new technologies have some investors questioning the future of traditional internet searches (and the digital advertising that comes with their results) that made Google-parent Alphabet (GOOGL 0.28%) (GOOG 0.29%) one of the world's largest tech companies.
Should investors give up on the tech giant? It would seem prudent for them to seriously consider the state of the advertising industry as it relates to AI. Still, Alphabet remains in solid shape, and investors should pay closer attention to three of its key attributes before writing off this communication stock.
1. Alphabet has plenty of plans that involve AI
Alphabet stock has struggled amid the latest advancements in AI technology. On the surface, the arguments against the Google parent make sense. If an AI chatbot can provide users with the information they desire in plain language, why would they keep using Google search -- and viewing the advertising on that platform? Since ads made up 78% of Alphabet's revenue in the first quarter of 2023, the decline of this business is a potential concern.
However, investors should remember that the company planned for this moment years ago. Initially known as Google, the company changed its name to Alphabet in 2015 to better reflect the non-Google businesses under its umbrella. It has acquired more than 200 companies, according to some estimates. Most of them seem to rely on AI, either explicitly or implicitly. On top of developing Google AI, one of the key AI-related acquisitions occurred in 2014 when Alphabet bought DeepMind, a general-purpose AI research company.
DeepMind has likely enhanced many of the company's products. And now, that research will likely become more focused as the company merged Google AI and DeepMind this year to form Google DeepMind.
Moreover, Google Cloud is now Alphabet's largest non-ad segment. Cloud services play a critical role in supporting AI, and Google Cloud is now the third-largest cloud provider by market share.
Image source: Synergy Research Group.
Additionally, in Q1, Google Cloud accounted for 11% of the company's revenue, up from 9% in the year-ago quarter. This growth not only reduces the importance of ads to Alphabet, but it also makes it more of an AI company.
2. Alphabet's got a strong cash position
Finding funds to invest in AI research is no problem for Alphabet. In Q1, the company claimed more than $115 billion in liquidity. Few companies hold such sizable cash hoards -- Alphabet possesses one of corporate America's strongest balance sheets.
More importantly, that amount of cash gives Alphabet tremendous optionality. It can buy the AI capabilities and revenue streams it cannot develop in-house. Also, it could invest in other endeavors should newer technologies supersede the current iterations of AI. Regardless of what happens to the digital ad business, it positioned itself well to adapt.
Also, despite its liquidity, it does not pay a dividend. While one could make solid arguments as to why Alphabet should offer such payouts, not doing so leaves it with more money to invest in the business.
3. Alphabet's stock has a favorable valuation
The effects of the AI trend have not been as negative for Alphabet's stock as one might assume. Admittedly, it underperformed its mega-tech peers. Still, despite the negative sentiment about the company, year to date, the stock has significantly outperformed the S&P 500.
Moreover, because it has lagged its peers, it's now trading at a more favorable valuation than they are.
On the one hand, its price-to-earnings ratio is up from the high teens levels it fell into during the depths of the 2022 bear market plunge. But at its current earnings multiple of 27, it is still a lower-cost stock than cloud peers such as Amazon, Microsoft, and Apple. If you're looking to buy a mega-cap tech stock now, Alphabet could be one of the more lucrative opportunities.
Consider Alphabet stock
Despite fears of a decline in its digital ad business, Alphabet remains worthy of investors' consideration. Concerns about a segment that provides 78% of its revenue bring uncertainty.
However, Alphabet has planned for this moment for a long time. With its investments in AI, its growing cloud business, and its massive cash position, the company will likely adapt to whatever challenges come in the rapidly changing tech market.
