Artificial intelligence (AI) promises to usher in a new era of labor productivity by automating a wide variety of business processes, from clerical work to coding. Indeed, Goldman Sachs says two-thirds of occupations could be partially automated with AI by 2030, and that could more than double the output of the average knowledge worker, according to Ark Invest.
Excitement surrounding AI has helped investors shake off the bear market blues. The S&P 500 has soared 19% year to date, leaving the index just 4% from a record high. In other words, the S&P 500 is very close to bull market territory. But the AI boom could send the stock market much higher in the years ahead, and because of its connection to AI, some Wall Street hedge fund managers are betting big on Alphabet (GOOGL 1.76%) (GOOG 1.65%).
Specifically, billionaires David Tepper and Bill Ackman have more than 10% of their portfolios invested in the company, and fellow billionaire Chris Hohn has allocated more than 8% of his portfolio to Alphabet stock. Given their enormous net worth, it's fair to assume all three money managers know a thing or two about the stock market.
Is now a good time to buy a few shares of this AI growth stock?
Alphabet impressed Wall Street with its Q2 report
Alphabet's growth decelerated the past few quarters as economic uncertainty prompted businesses to pull back on ad spend. That trend continued in the second quarter, but the company still topped Wall Street's consensus estimates on the top and bottom lines. A visual breakdown of the income statement is shown in the infographic below.
Image source: The Motley Fool.
On the top line, revenue climbed 7.1% year over year to $74.6 billion, driven by spectacular growth in the Google Cloud and Google Other segments. The former includes the sale of cloud computing services and enterprise collaboration tools like Google Drive, and the latter includes the sale of YouTube subscriptions and mobile apps through the Google Play store.
On the bottom line, generally accepted accounting principles (GAAP) net income rose 14.8% year over year to $18.4 billion, indicating that headcount reductions and other efforts to control costs are paying off. Investors can expect that trend to continue. CFO Ruth Porat made the following comment during the earnings call: "We remain very focused on durably reengineering our cost base."
Alphabet has big opportunities in digital advertising and cloud computing
Alphabet is the largest adtech company in the world. It collected nearly 30% of digital ad spend last year, and Google Search and YouTube are the foundation of that success. Google Search holds north of 92% market share in internet search, and YouTube is the top streaming service in the U.S. as measured by viewing time. The popularity of those web properties makes Alphabet a valuable advertising partner, but it also points to another advantage: expertise in artificial intelligence.
Alphabet leans on ever-evolving and increasingly complex AI to improve Google Search results, YouTube content recommendations, and the performance of Google Ads campaigns, and its product pipeline is filled with noteworthy innovations. For instance, Alphabet plans to bring generative AI capabilities to Google Search to accelerate information gathering, and it recently debuted generative AI tools for advertisers that streamline campaign creation. That puts the company in a good position. The global adtech market is expected to grow at 13.7% annually to reach $2.4 trillion by 2030.
Alphabet is also the third-largest cloud computing company, and its market share is climbing. Google Cloud collected 10% of cloud infrastructure and platform services spend in the first quarter, up from 8% one year earlier and 7% two years earlier. That momentum stems from strength in several areas, including AI infrastructure, conversational AI platforms, and cloud AI developer services.
But Alphabet aims to take more share with new AI products. It recently debuted developer tools for building generative AI applications, and it launched a digital assistant that brings generative AI capabilities to its enterprise collaboration software. Those innovations should help Alphabet maintain its momentum in cloud computing, a market expected to grow at 14.1% annually to reach $1.6 trillion by 2030.
As a final thought, while Alphabet's primary growth engines lie in adtech and cloud computing, its autonomous driving subsidiary Waymo and its AI research unit DeepMind could evolve into sizable revenue streams in the future.
Is Alphabet stock a buy?
At a minimum, Alphabet should be able to grow revenue at 14% annually through the end of the decade. I say that because adtech and cloud computing sales are expected to grow that quickly over the same period. Of course, Alphabet could conceivably grow even faster if it continues to gain market share in the cloud, or if other bets like Waymo and DeepMind pay off.
With that in mind, shares currently trade at 5.9 times sales, a small discount to the five-year average of 6.2 times sales. That is a reasonable price to pay given the potential upside, so investors should feel comfortable buying a small position right now. But I wouldn't put 10% of my portfolio in Alphabet, or even 5% for that matter. There are plenty of other AI growth stocks worth owning that sell at cheaper valuations.
