Earlier this year, there were indications that investor sentiment might have turned against Alphabet (GOOGL 0.72%) (GOOG 0.82%). The increased attention on artificial intelligence (AI) led some to fear that users would no longer need Google's search engine and would likely see less of its advertising. Ads, which once constituted almost all its revenue, remain very important to Alphabet's top line.
In July, the latest earnings report showed the company's income growth has begun to recover. The bulls are saying that AI competition fears are overblown and Alphabet will do just fine. I'm inclined to side with the bulls here. Considering its vast resources, one can make a solid argument why the Google parent remains a buy for most investors. Here's that argument.
Alphabet's second quarter
Admittedly, Alphabet's revenue has slowed considerably from the rapid growth of the past. The company's $75 billion in Q2 2023 revenue grew by only 7% compared to 2022's second quarter. Still, contrary to all the concerns about advertising, Google search revenue rose, and overall, ad revenue grew by 3% year over year. And even though the $58 billion in ad revenue still makes up 78% of Alphabet's overall revenue, the company continues to diversify its revenue sources. To that end, the $8 billion generated by Google Cloud grew to account for 11% of the company's revenue, and that segment of the business rose 28% compared to year-ago levels.
That cloud segment growth helped overall quarterly net income rise to more than $18 billion, surging 15% year over year as expense growth lagged the pace of revenue increases. Moreover, Alphabet continues to generate massive free cash flows. In Q2, free cash flow came in at $22 billion, 73% more than the same quarter last year. That bolsters its considerable liquidity, which now amounts to more than $118 billion.
Alphabet and AI
The Google parent has long used its cash reserves to invest in AI. On the second-quarter earnings call, CEO Sundar Pichai reminded investors that Alphabet became an "AI first" company seven years ago, and it has worked to incorporate AI into its products since that time. Admittedly, outside competition this year may have prompted the company to merge DeepMind and the Brain team from Google Research into Google DeepMind.
Nonetheless, the company announced it had incorporated its Search Generative Experience (SGE) into the search engine, which adds the power of generative AI to Google Search. Additionally, it has added enhancements to its proprietary large language model, Bard. It has also encouraged AI-driven innovation with additions such as optimizing Google Cloud's infrastructure.
Alphabet also mentioned that advertising would continue to play a key role in the company's future, and it will optimize its advertising through AI. This news and the continued innovation should reassure shareholders that the company can retain its major revenue source while driving AI innovation.
Alphabet's stock performance lately
Despite a perception that the Google parent had fallen behind, its stock price has risen by nearly 50% since the beginning of the year. Yes, that lags some AI powerhouses like Nvidia. Still, it isn't far from matching the performance of Amazon and is well ahead of Microsoft, which appeared to frighten Alphabet and other peers with its alliance with ChatGPT maker OpenAI. At a P/E ratio of 28, it sells at a discount to these peers, even Microsoft, which trades at 34 times earnings.
Don't give up on Alphabet
Competition in AI should not diminish the value proposition of Alphabet stock. Yes, its peers have made gains in the field, and one can certainly question whether the Google parent has made the right strategic decisions.
However, Alphabet is hardly new to the AI field, and time will tell how such functions enhance the top and bottom lines. But its $118 billion in liquidity available gives it a tremendous ability to buy AI companies or course-correct in-house. Hence, it is highly likely Alphabet will remain a crucial AI stock.
