Many savvy technology investors and entrepreneurs agree: The AI revolution is the real deal, and will likely transform our lives in the years to come. But unlike other disruptive revolutions, this one should actually benefit many current incumbent technology giants. These powerful companies are, after all, the only ones with the massive financial war chests and diverse technology know-how to deploy this extremely expensive and difficult technology at scale.
No wonder the Magnificent Seven Stocks have taken off recently. But while AI chip leader Nvidia (NVDA +2.59%) gets most of the attention, its stock has also taken off into the stratosphere and trades at a high valuation for a chip stock.
That's why billionaire hedge fund manager Dan Loeb is betting on one of the cheapest Mag Seven stocks as his new AI bet instead.
NASDAQ: GOOG
Key Data Points
Third Point Invests in Alphabet in Q1
In his first quarter letter to shareholders, Loeb detailed the firm's new buy of Alphabet (GOOG 0.21%) (GOOGL 0.41%) as a cheap way to play the AI race.
It should be noted that Loeb also said AI-related bets comprised about half of Third Point's holdings today. So, Loeb is clearly bullish on this powerful trend, which accelerated following the debut of ChatGPT in November 2022.
The problem is, of course, that AI stocks rarely come cheap these days. But as Loeb spelled out in his Q1 letter, Google's initial missteps in the rollout of its large language model, Gemini, which seeks to compete head-to-head against ChatGPT, provided that window of opportunity.
The much-anticipated rollout of Gemini in February didn't go quite as planned. When prompted by early users to create historical images, Gemini often depicted racially diverse figures in historical settings in which it was not historically accurate to do so, and these politically charged inaccuracies were well-publicized. In response, Google's stock fell to a year-to-date low in early March.
However, Loeb wrote in his letter:
Assigning primacy to a small operational misstep while demoting the fact that the company has been building world-class capabilities in AI for over a decade, created an attractive entry point for a long-term investor. While it is easy to forget that the original paper on Transformers which paved the way for the rise of LLMs was published by Google engineers, and that it was Alphabet that built two of the leading AI research organizations (Google Brain and DeepMind), when news reports previewed Apple's (AAPL 0.01%) intentions to embed Gemini into iOS, investors paid attention. We believe the moment when Gemini takes a seat at the economic table is approaching.
Not only does Loeb see Alphabet's AI team eventually working out the kinks in Gemini to make it a pre-eminent LLM, Loeb also notes AI has the potential to greatly enhance Alphabet's current core businesses across Search, YouTube, Android, cloud and others. And rather than being threatened by AI, Loeb thinks Google Search could actually become even more of a trusted source of information, as the post-AI internet becomes full of "ad-supported content full of fakes."
Dan Loeb bet on Alphabet in the first quarter 2024. Image source: Getty Images.
The bet pays off
Loeb had good reason to expound on Third Point's Alphabet position in the first quarter. Five days before his letter came out, Alphabet reported first quarter earnings that handily beat analyst expectations. In addition, the company announced its first-ever dividend payment, which amounts to a 0.5% dividend yield at this stock price.
The dividend payment was interesting, as management showed confidence in its growth path while also giving a nod to the company's newfound focus on operational efficiency since the downturn of 2022.
In any case, Alphabet rallied higher following the April 25 release, and is now up about 20% on the year and roughly 25% from it March lows.
How Alphabet's stock looks after the rally
Even after its recent rally, Alphabet trades at less than 26 times trailing earnings and just 21 times its 2025 earnings estimates. That's still among the cheapest of the Magnificent Seven stocks. Not only that, but Alphabet also has a substantial $108 billion cash hoard, and it's still losing over $1 billion every quarter on its "Other Bets" segment.
Stripping out those two factors, and Alphabet's core Search, YouTube, Android, and Cloud businesses are trading at an even cheaper valuation than Alphabet's headline P/E ratio would suggest. In this Alphabet shareholder's opinion, investors would do well to follow Loeb into the stock for the long term.
