One of the most interesting investors on Wall Street is Bill Ackman. Ackman is the CEO of Pershing Square Capital Management, a hedge fund primarily focused on technology and consumer businesses.
What differentiates Ackman from other money managers is that his portfolio generally holds a small number of stocks as opposed to a large basket of diversified opportunities.
Currently, while other portfolio managers are buying up big tech on the backdrop of an exciting narrative surrounding artificial intelligence (AI), Ackman only owns one member of the "Magnificent Seven."
Approximately 18.4% of his portfolio is allocated to Alphabet (GOOG 1.06%) (GOOGL 1.08%), a leader in internet search and cloud computing.
Let's dig into why Ackman has such high conviction for Alphabet, and assess if now is a good opportunity to scoop up some shares.
Advertising is the core business, but...
Alphabet owns two of the world's most visited websites: Google and YouTube. Despite intense competition from Meta Platforms and TikTok, advertisers are eager to take advantage of Alphabet's enormous surface area on the internet.
Unsurprisingly, the company is able to command immense pricing power from its advertising partners, leading to robust revenue and profit growth.
During the first quarter of 2024, Alphabet generated $70.4 billion of revenue from the services segment -- an increase of 14% year over year. The company's services segment combines advertising and sales of subscriptions and devices. While advertising comprises more than three-quarters of Alphabet's total sales, it's the margin profile that I think is even more important.
Alphabet's services segment reported a 40% operating margin. By comparison, this division's operating margin was 35% during the first quarter of 2023.
By expanding margins, Alphabet is able to produce excess cash flow that it can use to reinvest into the business. Some of the more prominent areas for internal investment include cloud computing and AI, among other shareholder rewards programs.
...cloud computing could be a hidden gem
Cloud infrastructure is dominated by Amazon and Microsoft. However, Alphabet has demonstrated its ability to compete at a high level in this arena.
During the first quarter, sales of Google Cloud Platform rose 30% year over year to $9.6 billion. Similar to the services business, Alphabet's cloud operation is consistently profitable. This is a notable feat, because just two years ago Google Cloud was a major source of cash burn for Alphabet.
A major reason for the turnaround in the company's cloud business is AI. Large enterprises including Uber Technologies, Etsy, PayPal, and Bristol Myers Squibb are utilizing AI-powered services within Alphabet's cloud platform.
By marrying AI with the cloud, Alphabet is able to offer a full spectrum of products and services across its ecosystem -- spanning workplace productivity, cybersecurity, and accelerated computing.
Image source: Getty Images.
What is Alphabet doing with its cash pile?
At the end of Q1, Alphabet held $108 billion of cash and equivalents on its balance sheet. In addition to aggressive ambitions in AI, Alphabet has found some other creative ways to ignite some excitement from shareholders.
Namely, Alphabet announced that it is repurchasing up to $70 billion of stock. This is an interesting move because it could suggest that management views Alphabet stock as undervalued, despite a 17% gain so far this year.
I think what really surprised investors was the announcement of Alphabet's first ever dividend. I see this as a strategy to win over shareholders, and a sign that management sees sustained, robust cash flow in Alphabet's future.
GOOG PE Ratio (Forward) data by YCharts
There aren't many companies that have as broad a reach or as diversified a business profile as Alphabet. And yet, Alphabet's forward price-to-earnings (P/E) ratio of just 22.1 is among the lowest of the Magnificent Seven peer set.
I think a lot of investors are missing the forest for the trees when it comes to Alphabet. The themes explored above clearly indicate that Alphabet is making notable inroads in AI and has the potential to benefit in many different ways. More importantly, these investments are already yielding efficiencies for Alphabet.
As a result, the company carries a staggering amount of cash, which it is using to further penetrate the AI realm, all while rewarding shareholders through stock buybacks and dividends.
Ackman could be onto something as it pertains to his large allocation of Alphabet stock. Investors with a long-term time horizon may want to consider scooping up shares in Alphabet at its current valuation. To me, the company's best days are ahead and the stock looks dirt cheap right now.
