What happens when the hype subsides? That is what investors should ask themselves about Google's parent company Alphabet (GOOG 0.60%) (GOOGL 0.71%).
There is little doubt that the company was caught with its pants down when OpenAI introduced ChatGPT. Microsoft took advantage, investing billions to bring the large language model (LLM) chatbot to its Bing search engine. Many companies have tried and failed to hedge into Google Search's dominance over the years, but this is a real threat ... right?
But with a 10% month-over-month traffic drop in June, users spent less time on ChatGPT's site on average. And iPhone downloads are down a startling 38%. So the ChatGPT buzz is quieting already.
Meanwhile, Statista's latest report shows Google Search gaining ground in the last few months, holding 85.5% of the desktop market to Bing's 8.2%. So Google is much tougher to dethrone than many seem to think.
Alphabet stock lags the recovery
Tech stocks have rebounded nicely over the past year as artificial intelligence (AI) opportunities, slowing inflation, and resilient earnings spark optimism. But Alphabet stock has lagged behind its peers, as shown below.
GOOG total return level data by YCharts.
Much of the lag is due to sentiment; multiple analysts have cut their ratings on the stock, citing AI threats. But Alphabet is far from being left out of the AI race. It has been developing AI solutions for years with some of the brightest minds in the business and recently combined its teams into one called Google DeepMind.
Its next-generation LLM, PaLM2, was recently introduced and promises higher-level reasoning, coding, and language generation for use in multiple products like the chatbot Bard, Google Docs, and cybersecurity applications.
When the market realizes Alphabet is actually an AI leader, sentiment could turn on a dime.
Is Google stock a buy?
Sometimes the strength of the underlying business gets lost in the conversation. It's easy to forget that Alphabet generates massive cash flow from operations: $91 billion in each of the prior two years plus $24 billion in the first quarter. So the business is very strong.
CEO Sundar Pichai is working to make the company 20% more efficient, and more agile. The first quarter showed the plan in action as the company took $2.6 billion in downsizing-related charges. The Google Cloud segment also showed an operating profit for the first time on record in the quarter. This segment grew sales by 28% year over year in the face of a challenging economy after doubling revenue from $13 billion in 2020 to over $26 billion in 2022.
Meanwhile, as depicted below, Alphabet lags both Microsoft and its historical averages in price-to-earnings (P/E) and multiple cash-flow ratios.
GOOG price-to-free-cash-flow data by YCharts. TTM = trailing 12 months.
Investors also benefit from Alphabet's lucrative share buyback program. The company has used its significant cash flow to take $155 billion in stock, or 10% of the current market cap, off the market since 2020. This means shareholders will benefit even more when ad dollars return and earnings ramp up.
Stocks like Nvidia and Microsoft are the talk of Wall Street and Main Street. But to paraphrase famous hockey player Wayne Gretzky, we shouldn't skate to where the puck is; we need to skate to where it's going.
With its AI initiatives, stranglehold on search, crazy-good cash flow, and profitable and growing cloud segment, all signs point to Alphabet.
