As a company gets larger, sometimes the business segment that got it to that point isn't the reason why investors might want to invest in it in the future.
For Alphabet (GOOG 1.25%) (GOOGL 1.20%), advertising on Google got it to where it is today. While that may be a solid business now, Alphabet has another segment I'm much more excited about that will drive it to its next growth phase. Let's dive in and take a look.
Cloud computing has a massive runway
The business I'm talking about is none other than Google Cloud. Alphabet's cloud computing offering is a vital part of its business and continues to grow and do well even as its advertising wing struggles. The shift from on-premises computing to cloud computing is a massive trend; Fortune Business Insights pegs the market opportunity at $2.4 trillion by 2030.
There are a lot of competitors in cloud computing, but also a huge market to go around, so even though Google Cloud has only the third-largest market share among cloud infrastructure providers (behind Amazon Web Services and Microsoft's Azure), it can still provide Alphabet a massive business boost.
In the second quarter, Google Cloud's revenue grew 28% year over year. It also continues to improve its profitability as it posted a 5% operating profit, up from Q1's 3%.
Once fully built out, this business can be highly profitable as Amazon Web Services has consistently posted operating margins of around 25% for a number of years. So if Google Cloud can continue growing at this rate plus achieve a strong operating margin, this business will become an incredible cash cow for Alphabet.
Still, Alphabet's other businesses aren't doing that bad either.
Search advertising is holding on
Alphabet still derives most of its revenue (78% in the second quarter) from advertising-related sources. This business has struggled lately as the ad market is weak due to macroeconomic uncertainty. With the company's ad revenue only rising 3% in Q2 (led by Google Search's 5% rise), it's clear that the advertising market is a bit weak.
Still, the fact that its ad sales grew at all shows how dominant Alphabet is in the search industry.
All of this combined leads to what investors care about most: profits. In Q2, Alphabet improved its operating margin by 1 percentage point year over year to 29%, allowing it to post a strong earnings per share number of $1.44. Additionally, because Alphabet took $2 billion in charges related to its workforce reduction, this number should be even better next year.
In the trading session after it revealed all this good news, Alphabet's stock popped by 6%. However, I think it could be poised for even more. Alphabet's stock trades at 23 times forward earnings -- a great price for the stock considering where the stock has historically traded.
GOOGL PE Ratio (Forward) data by YCharts.
Furthermore, as Alphabet's advertising revenue recovers and Google Cloud grows over the next few years, its earnings should rise substantially.
Considering that Alphabet is one of the most reasonably priced big tech stocks and has a massive runway in front of it, Alphabet is still a fantastic buy right now. Investors should consider adding this stock to their portfolios or adding to their existing positions after last week's fantastic earnings report.
