Warren Buffett's longtime friend Bill Gates introduced him to ChatGPT in 2023. After playing around with it, Buffett was impressed by the technological advances demonstrated by the chatbot. He saw the enormous potential for it to save people a lot of time.
Nonetheless, Buffett has maintained his habit of being somewhat averse to technology companies. Berkshire Hathaway (BRK.A +0.05%) (BRK.B +0.07%) hasn't made any investments that are directly tied to the generative AI trend since the release of ChatGPT. At least, it hadn't until last quarter.
The only new stock it reported purchasing in its third-quarter Form 13F filing with the SEC has already climbed by more than 25% from its high during that period. And despite that, it might not be too late for retail investors to follow Berkshire's lead and buy the stock today.
Image source: The Motley Fool.
The big bet on artificial intelligence
Berkshire Hathaway bought 17.8 million shares of Alphabet (GOOGL +1.75%) (GOOG +1.61%) last quarter. It's a stock Buffett has long had his eye on, noting that he viewed it as a missed opportunity all the way back in 2018. It's not clear whether he or one of the other investment managers at Berkshire finally pulled the trigger, but Alphabet is now Berkshire Hathaway's 10th-largest U.S. stock holding.
Alphabet is far from being the simple type of business that Buffett prefers. But there are a couple of businesses at its core that aren't so complicated that the potential for them to be disrupted is unpredictable. Alphabet operates Google Search and YouTube, two of the world's most widely used web platforms, and sells advertising on them. Additionally, it operates a growing public cloud computing platform, building data centers and renting out their computing power.
Perhaps that's oversimplifying things a bit, but here's the great, important detail that Buffett and his team may have found most attractive. It's a cash-generating machine. Thanks in large part to its high-margin advertising business and its increasingly profitable cloud business, it has produced $73.6 billion in free cash flow over the trailing 12 months. That's despite its heavy spending on building new data centers to take advantage of the AI opportunity that management sees.
As Google Cloud scales up, it has demonstrated the improved operating leverage many expected from the business. Operating margin came in at 24% last quarter, up from 17% a year ago. That's helped propel overall earnings growth as the Search business has remained resilient in the face of competition from AI chatbots.
As a result, the stock traded for a forward P/E ratio of less than 20 for most of the third quarter. That multiple climbed above 24 after a court ruling in Alphabet's antitrust case that was more favorable to the company than many expected, but that's still an extremely attractive multiple for a business that's grown its earnings per share by 35% year over year through the first three quarters of the year, with positive signs for continued growth.
NASDAQ: GOOGL
Key Data Points
It's not too late to buy Alphabet
Shares of Alphabet have been on an incredible run since September. As mentioned, it received a favorable court ruling, allowing it to maintain default search engine contracts for web browsers with limited restrictions. Those agreements have been key factors in ensuring Google maintains its dominant position as the leading search engine.
It then reported strong third-quarter results, with better-than-expected revenue and earnings. Importantly, its cloud backlog surged 82% year over year, giving investors more confidence about the company's massive spending plans. Management increased its capital expenditure budget to $91 billion to $93 billion for the year, up from an initial outlook of $75 billion.
Alphabet shares received an additional boost after the Berkshire disclosure, and continued climbing after a positive reception of its Gemini 3 AI model, which scored better than top competitors from Anthropic and OpenAI on nearly every benchmark test. Gemini is key to Alphabet's maintaining Google's position in the AI era through AI-assisted search features and licensing its tools to developers. The latest model's improvements should give the core business another boost.
On top of that, The Information has reported that one of Alphabet's biggest rivals, Meta Platforms, is considering a deal to use its Tensor Processing Units (TPUs) in its data centers and also renting capacity on those custom AI accelerator chips from it via Google Cloud. That's on top of a deal with Anthropic to use TPUs to power some of its workloads starting next year. Considering the amount Meta and Anthropic are spending on AI development, both could be massive additions to Google Cloud's rapidly growing backlog.
All of this good news has sent shares of the stock from a forward P/E multiple of less than 20 just a few months ago to nearly 29 today. That would still be a bargain price for a company that's grown its bottom line at the rate Alphabet has over the past year.
However, there are a few headwinds to note. In particular, depreciation will start showing up on the income statement over the next few years as Alphabet expenses its massive data center spending. While that might weigh on its margins, that will be offset by the benefits of scaling Google Cloud and the continued growth of the company's high-margin advertising business. Overall, a price around 30 times earnings expectations still looks like a fair price for the business, considering the positive results and momentum in its AI business.
