Alphabet (GOOG 1.16%) (GOOGL 1.32%) was slammed last week when a testimony from an Apple (AAPL -0.07%) executive stated that he expects traditional search engines to disappear and be replaced with artificial intelligence (AI)-powered search features. This news caused Alphabet's stock to tumble 7%.
In the first quarter, 56% of Alphabet's revenue came from the Google search engine, so this is clearly a huge part of its business. If Google search is replaced by AI, could that be the end of Alphabet's stock as investors know it?
Image source: Getty Images.
Alphabet's management is already aware of this challenge
The news that AI-powered search will replace traditional search engines isn't news to Alphabet management's team. It's well aware of the challenges it faces and has already worked to incorporate AI into search results.
Instead of rummaging through information from a Google search, users now find an AI summary presented at the top of the page. Alphabet's management mentioned on its Q1 conference call that this is an incredibly popular feature that's still growing its user base. Furthermore, the company is working on adding additional features and expanding its use cases.
So, even though the stock market reacted negatively to the news that Apple delivered to federal court, I don't think investors should follow suit. In fact, they should be rejoicing.
Why should they rejoice? Well, Alphabet may not need to pay Apple as much money to become the default search engine on its products.
Alphabet's stock is dirt cheap
In 2022, Alphabet paid Apple $20 billion to be the default search engine on Apple's products. This landed Alphabet in hot water and was a key factor in the illegal monopoly case against the Google search engine. Apple's executive Eddy Cue mentioned that Apple may offer AI-powered search alternatives to users rather than defaulting to Google. If that's the case, Alphabet wouldn't need to pay Apple because it wouldn't have the default status anymore. If that happened, Alphabet's profits would jump by $20 billion immediately.
Considering that Alphabet has generated around $111 billion in profits over the past 12 months, this would provide nearly a 20% increase in profits overnight.
GOOGL Net Income (TTM) data by YCharts
However, if Apple gave users the choice of what platform they'd use, Alphabet would likely lose some revenue due to some users opting for an alternative to Google. So, it would be unlikely that all of the $20 billion would make it to the bottom line. But I'd say a large chunk of it would still be there because the Google search engine is still the most popular worldwide by a wide margin, and many users would likely select it anyway.
So, this isn't the end for Alphabet's stock; it's more like a new beginning.
The market doesn't see it this way, and Alphabet's stock recently traded for a dirt-cheap 16 times forward earnings.
GOOGL PE Ratio (Forward) data by YCharts
That's a very inexpensive price to pay for a company that's still growing at a healthy rate. To add another catalyst, if Alphabet doesn't have to pay Apple $20 billion, an expense would be eliminated overnight and added directly to Alphabet's earnings. This would decrease the denominator of the price-to-earnings (P/E) ratio, making the stock even cheaper.
Although the rest of the market may be a bit fearful about Alphabet's stock, I think the pessimism is unwarranted. The current stock price represents excellent value for those who can endure many headline-induced fears.
