Artificial intelligence (AI) companies come in all shapes and sizes. One of the most dominant varieties is the big tech companies that are trying to weave AI into their inner operations and transform their business into one powered by AI. Two companies that fit this bill are Meta Platforms (META +0.23%) and Alphabet (GOOG 0.21%) (GOOGL 0.41%).
Both of these companies are among the most valuable in the world, but they didn't grow their business on AI. Instead, both of them view AI as the technology that will take their business to the next level and view themselves as AI-first companies.
However, the market isn't giving their stocks a high valuation due to their current business models. This pessimism opens the door for long-term investors, as AI could have a massive impact on both companies in the not-too-distant future.
Image source: Getty Images.
Advertising is the main focus of both businesses
The problem with Meta Platforms, the operator of social media sites like Facebook and Instagram, and Alphabet, the operator of the Google search engine and YouTube, is that they both get a massive chunk of their revenue from advertising.
In the first quarter, about 77% of Alphabet's revenue came from advertising-related sources. Meta Platforms' dependence on advertising is even greater, with 98% of its revenue coming from ads.
NASDAQ: META
Key Data Points
It's pretty obvious, but when the advertising market is good, these two will excel. When it takes a downturn, they both can struggle. Advertising markets tend to get weaker during an economic downturn because it's one of the easiest expenses to cut. With less demand for ads, the price of an ad falls, which hurts Alphabet and Meta Platforms.
While nobody knows for sure if the economy is heading straight into an economic downturn, the outlook doesn't look promising, which is why these two stocks don't get the premium valuations that some of their big tech peers do.
GOOGL PE Ratio (Forward) data by YCharts
Considering that the S&P 500 (^GSPC 0.11%) trades for 21.1 times forward earnings, Alphabet is quite a bit cheaper than the broader market, while Meta is only slightly more expensive. I think this makes them potential buys based on their valuations alone, but the transformation that AI could have on both of their businesses is the real reason I'm considering buying them here.
AI is a huge part of both companies' futures
Although Alphabet was a bit late to the AI party, its Gemini model still ranks among the top options available. According to management, its AI Overviews search summary tool, which appears at the top of Google searches, has been an incredibly popular feature.
NASDAQ: GOOGL
Key Data Points
Alphabet also supplies the tools and infrastructure to build AI models, especially with its cloud computing offering, Google Cloud. Google Cloud offers its clients best-in-class training hardware, including custom Tensor Processing Units (TPUs) and the latest cutting-edge GPUs. This makes it a popular option for building AI models, and its success is reflected by its 28% revenue growth in Q1.
Meta Platforms calls out five areas where it sees AI impacting the business:
- Improved advertising
- More engaging experiences
- Business messaging
- Meta AI
- AI devices
While those aren't very descriptive opportunities, they encompass everything Meta tries to do. The biggest is improved advertising, as Meta gets most of its revenue from this area. The key to a successful ad business is finding and targeting an audience, and AI is a perfect tool for that. This has the potential to boost sales for the client and Meta, and is a big reason that AI is a monster opportunity for Meta.
Additionally, if any of Meta's AI devices take off and become massive hits (such as its glasses), it could open a whole new revenue stream that isn't accounted for in the company's valuation.
Alphabet and Meta have big upside powered by AI, but the market only values them for their current advertising-focused businesses. As a result, I think now is an excellent time to scoop up shares, as the ad market will eventually recover from an economic downturn, and new AI revenue streams may rise for Meta and Alphabet during that time frame, making the business much more robust three to five years from now.
