Alphabet CEO Sundar Pichai Says AI Start-Ups Are Choosing Google Cloud -- Time to Buy the Stock?

Alphabet (GOOGL 0.47%) (GOOG 0.52%) and its important Google Search product reported warming financials to match the July heat. Revenue and earnings per share (EPS) increased 7% and 19%, respectively, beating expectations and breaking the streak of year-over-year EPS declines the internet giant had been reporting during the inflation-tinted bear market.

Besides Google Search, YouTube, and other online advertising revenue rebounding, Google Cloud was in the spotlight -- and Alphabet CEO Sundar Pichai mentioned a big reason for investors to cheer on this department. Google Cloud counts many top artificial intelligence (AI) start-ups as customers. Is it time to buy Alphabet stock as the AI hype cycle rages on? 

Google Cloud's collection of AI "unicorn" customers

First, as a brief refresher, cloud computing is internet-based access to computing power, data, and software stored in a remote data center. Google Cloud's infrastructure has been growing quickly for years, but remains in third place behind giants Amazon Web Services and Microsoft Azure; it still has a lead on the emerging fourth player Oracle Cloud. 

Despite its smaller size, Google Cloud once again notched an impressive growth rate in the second quarter of 2023, up 28% from the year prior to $8 billion -- or just over 10% of total revenue. 

Helping fuel that expansion is the current generative AI craze spurred on by the conversational chatbot ChatGPT. Google has its own AI chatbots it's testing and improving on, but Pichai explained why Google Cloud might be far more exciting an investment for this new era. He said on the earnings call: "Our AI-optimized infrastructure is a leading platform for training and serving generative AI models. More than 70% of gen AI unicorns are Google Cloud customers, including Cohere, Jasper, Typeface, and many more."

What exactly is an AI unicorn? In Silicon Valley parlance, a "unicorn" refers to a privately owned start-up company with a valuation of at least $1 billion. After an ugly 2022 bear market for the start-up and venture capital industry, lots of new unicorns have been minted. And while the average retail investor can't (and may not even want to) invest in these companies, owning Alphabet provides a sort of back-door access to these start-ups via Google Cloud's top cloud AI infrastructure service. Boasting 70% of these fast-moving tech outfits as customers is quite the feather in Google's hat.  

Even better than cloud AI growth

It gets better than that. Pichai also explained how Google Cloud's investment in infrastructure -- including the latest and greatest Nvidia chips, as well as Google's own in-house developed chips for AI called TPUs -- is leading to larger and more complex deals. Pichai explained companies from mobile application management company AppLovin to global banking giant HSBC to pharmaceutical leaders like Pfizer are all making use of an expanding library of Google Cloud generative AI software in their daily operations. The result has been more efficient workflows and cost savings for these customers.

Google Cloud seems to be eating its own cooking, too. After years of growth but operating profit margins in the red, Google Cloud itself has tightened its belt and is rapidly increasing its profitability.

Data source: Alphabet.

A top catalyst for profitable growth

Google Search and YouTube advertising have long been the focus for Alphabet shareholders. Google Cloud has been an underappreciated third growth lever, and now it's only just beginning to kick in on the bottom line as well. Going from negative margins to robustly profitable ones can have a dramatic impact on Alphabet's overall results, as seen in the company's 7% revenue growth in Q2 but far faster 19% EPS growth.

And of course Alphabet can use this new Google Cloud and AI hype cash flow to keep boosting its returns to shareholders. Alphabet has turned into a stock buyback machine. It has returned $29.5 billion to investors this year via share repurchases, about a 3.5% increase over last year. The company has plenty of room to do more in the coming years with its $118 billion in cash and short-term investments on its balance sheet.

The stock market is heating back up this year, driven by investors who parked cash on the sidelines in 2022 during the bear market, and are now plowing that cash back into high-growth tech stocks touting their work in AI. But as the market melts up, Alphabet still looks like a reasonable play here, trading for about 20 times expected 2024 earnings. Alphabet and its Google Cloud service look like one of the "safer" ways to bet on the AI supercycle that is unfolding.