In a move that many would have once considered surprising, investors seem to have written off the artificial intelligence (AI) prospects of Google parent Alphabet (GOOGL +1.31%) (GOOG +1.10%).
The tech conglomerate, which first applied AI to its search engine in 2001, appeared to have lost a step in the AI race, when OpenAI released GPT-4o in 2023. Moreover, a recent commitment to invest heavily in capital expenditures (capex) -- most of which is presumably related to AI -- seemed to scare investors more than it reassured them.
Nonetheless, its longtime focus on AI technology and its vast resources will probably show that Alphabet can still compete in this field. Here's why Alphabet bulls should probably stay the course with its stock.
NASDAQ: GOOGL
Key Data Points
The state of Alphabet's AI
The market's reaction to Alphabet stock is a bit of an enigma. The search- and YouTube-driven digital ad business and Google Cloud generated nearly all the company's $350 billion in revenue in 2024, and AI played a significant role in that success. In addition, the growth of Google Cloud and investments in numerous other businesses signaled that the company has long planned to reduce the share of revenue driven from its legacy platforms.
Still, Alphabet analysts appeared caught off guard by the release of GPT-4o. Upon its release, the rhetoric seemed to turn against the Google parent, as some analysts questioned whether the dominant Google search engine would fall out of favor. Even when Alphabet released its own generative AI platform, Google Gemini, it did not appear to ease concerns.
More recently, Alphabet stated in its earnings report for the fourth quarter of 2024 that it would invest $75 billion in capital expenditures. This is up from the nearly $53 billion spent in 2024 and $32 billion allocated in 2023.
Admittedly, that is a staggering investment that few other AI companies can afford. Still, with competitors spending heavily on AI, Alphabet will likely have to invest in itself if it wants to remain a relevant force in this industry.
How AI has affected Alphabet
However, the negative AI news has not hurt its stock as much as some might assume. Since the release of GPT-4o on May 13, 2023, Alphabet stock has earned a total return of 65%. That lags the return of other AI stocks such as Nvidia or Palantir. Still, it came out slightly ahead of the S&P 500 (^GSPC +1.02%).
GOOGL Total Return Level data by YCharts
In addition, its P/E ratio of 23 is the lowest among the "Magnificent Seven" stocks. That discounted price could work in its favor if investors see an obvious, AI-driven catalyst.
Additionally, Alphabet can probably afford this investment. Indeed, it spent $62 billion on share repurchases in 2024, and its dividend is on track to cost the company $10 billion annually.
Nonetheless, Alphabet holds almost $96 billion in liquidity. Moreover, the company generated nearly $73 billion in free cash flow in 2024, an amount not including the capex spending. That would allow Alphabet to maintain the same pace of spending for years without having to add debt.
Furthermore, the capex investments will likely deliver returns that increase the company's free cash flows over time. While that leaves shareholders with some uncertainty, it is highly likely that Alphabet will remain competitive in the AI industry for some time to come.
Alphabet as an AI underdog
Although Alphabet's actions may indicate it is a slight underdog in the AI race, it is much too early to count out the tech conglomerate.
A pivot away from search in favor of AI could reduce usage of Google platforms and, by extension, its ad revenue. However, the company has long planned such a transition, meaning it is better positioned to deal with this disruption than some analysts may assume.
Additionally, the company holds tremendous resources and could likely afford the investments necessary to stay competitive. When also considering Alphabet's low valuation, it is likely investors can prosper by adding shares now.
