Alphabet (GOOG 0.18%) (GOOGL 0.14%) is perhaps the least-loved "Magnificent Seven" stock of all. Many investors are fearful of its base business being disrupted by generative AI products, but that weakness hasn't surfaced yet. Additionally, Alphabet has some other business units that are cashing in on the AI arms race and boosting its overall growth.
Alphabet's stock appears absurdly cheap right now, and investors willing to buck the trend can find huge value in its shares.
Image source: Getty Images.
Alphabet's base business is still doing just fine
Alphabet is the parent company of Google, YouTube, the Android operating system, and many other product lines. However, the Google search engine is the business's cash cow and allows the company to fund other projects. Without the cash generated by Google search, Alphabet wouldn't look the same way it does today.
Many investors are fearful that generative AI models will completely replace Google search, but we haven't seen that occur. Alphabet's management team has launched a new product that could bridge the gap between full-on generative AI usage and a traditional search engine. Its AI offers a generative AI-powered overview that summarizes the search.
While this feature has some quirks, it's incredibly effective and popular. Many investors are forgetting about how widespread and popular Google is. There is a massive consumer base that only knows Google and will likely never use an AI model, and these users will likely remain loyal customers unless something vastly improved is launched, which hasn't been the case.
Furthermore, the weakness investors are worried about hasn't materialized in Alphabet's results. During the first quarter, Google search's revenue rose 10% year over year. That's not much different than the growth it has delivered for many years, casting doubt on the hypothesis that Google search can't succeed in an AI-driven world.
Additionally, other divisions, like Google Cloud, benefit from the AI arms race. Google Cloud is Alphabet's cloud computing division, building massive amounts of computing power for customers to rent. Most clients don't need a dedicated AI computing cluster, so renting it from a provider like Google Cloud makes more sense. Google Cloud saw phenomenal growth in Q1, with revenue rising 28% year over year. Additionally, it's becoming increasingly profitable, with its operating margin nearly doubling from 9.4% last year to 17.8% this year.
This all adds up to a company (alongside other divisions) that grew revenue and diluted earnings per share at a 12% and 49% pace, respectively, during the first quarter. That doesn't sound like a dying company, and Alphabet is succeeding even if the market would have you believe otherwise. Normally, those growth levels would earn a stock a large premium, but it doesn't with Alphabet.
Alphabet's stock looks absurdly cheap
I'm using the S&P 500 index as the baseline comparison for Alphabet. The broad market index is one of the best comparison tools investors have to determine whether a stock is cheap or expensive. The S&P 500 currently trades at 22.8 times forward earnings, which is historically quite expensive.
Alphabet's stock is much cheaper than that, trading for a mere 17.4 times forward earnings.
GOOGL PE Ratio (Forward) data by YCharts
So, whether the broader market is expensive or Alphabet's stock is cheap doesn't matter (I think it's a combination of those two factors). Alphabet's stock is undervalued compared to the market, as it's delivering market-beating growth at a below-market price.
It's rare to find a stock that combines these two factors without being a highly cyclical business, which makes Alphabet a no-brainer buy at today's stock price.
