This article is an update of an article originally published on April 28th 2024. It has been expanded and updated with Q3 FY24 figures from October 29th 2024.
Since ChatGPT launched two years ago, there have been lots of articles about Google's parent company Alphabet GOOG 0.00%↑ and its uncertain future in the AI age. At first, people said that Google's dominance in search was being challenged by Microsoft Bing and its growing market share.
Then it was said that Google's own language models (Gemini) were lagging far behind OpenAI in the GenAI competition. Some analysts even claimed that Waymo could lose its market lead in autonomous driving to Tesla.
None of this has shown up in Alphabet's figures so far.
Right now, analysts are worried that Google's powerful search business might not be as important as it used to be with AI chatbot alternatives becoming more popular. They forget that since years Google has been developing new AI-powered search methods and testing their monetization.
Alphabet has just released another set of great results for Q3 2024, proving the doubters wrong, at least for now. The Alphabet share, which has been unpopular recently, rose a lot after the Q3 figures and is moving towards its all-time high, which it reached in July 2024.
Here is my current view of the situation surrounding the Alphabet stock, which has been the only Big Tech stock in my sample portfolio (High-Tech Stock Picking wikifolio) for quite some time.
The Alphabet Numbers For Q3 2024
Google's revenue increased by 15% year-on-year, reaching $88.3 billion in Q3. There were double-digit increases across almost all business areas. Thanks to the AI boom, Google Cloud Platform did especially well, with revenue up 35% to $11.4 billion.
It's also worth noting that YouTube's revenue from advertising and subscriptions exceeded $50 billion for the first time in the last 12 months. Netflix generated $37.5 billion in revenue over the same period, so YouTube is one-third larger than the streaming giant in terms of revenue.
Even though Google is trying to bring in more revenue from different sources, the search engine still makes up 56% of Alphabet's total revenue. This share is only dropping slowly because Google's search business is still growing at a double-digit rate. Could this be a real luxury problem?
What's even more important for the stock price than the revenue trend is that Alphabet has its costs well under control again. Needless to say, the numerous layoffs from 2023 played a part in this. I hope the company has learned from past mistakes (over-hiring until 2022) in the long term as well. In any case, the new CFO, Anat Ashkenazi, made it clear in her first earnings call that one of her top priorities is to advance "Cost Efficiencies" in the Google organization.
Alphabet's operating margin in Q3 2024 was a whopping 32%, up from 28% in the year-ago quarter. That meant an operating profit of over $28.5 billion.
The Google Cloud Platform (GCP) has also played a big part in this great result, with a huge turnaround in profits over the past three years. Google Cloud's operating profit multiplied from last year, with $1.9 billion in profits and a 17% margin.
All that time and money Google has invested in GCP is now paying off. Google Cloud Platform has made great strides in the startup space, even against market leaders Microsoft Azure and AWS. Its good integrability and openness give it a distinct advantage. Numerous software providers will operate their AI applications on the Google Cloud Platform in the future and are already ensuring a jump in Google Cloud's revenue.
Alphabet's net income for Q3 was $26.3 billion, which equates to earnings per share of $2.12 and a 37% increase on last year.
So far, so good. But if you look for weaknesses in Alphabet's figures, you'll find them.
In Q3, the free cash flow was $17.6 billion, which is well below the operating result, as it has been in previous quarters. The reason for this is the huge investment ($13 billion) in additional data center capacity. Just like Meta and Microsoft, Google is also investing heavily in additional AI infrastructure, which is only expected to pay off in the coming years.
The cash flow burden from AI infrastructure is set to continue in the current Q4. By 2025, investments are expected to increase again, though at lower growth rates than in 2024.
The position of Alphabet stock in the AI hype
In previous posts, I have argued that investor euphoria and expectations regarding the monetization of AI have become too great. Now, I am even talking about a clearly visible AI bubble that will burst sooner or later. See: We are in the Midst of a Dangerous AI Bubble - Will it Burst in 2025?
After chip makers (like Nvidia), the cloud providers like Microsoft, Amazon, and Google are now experiencing an AI-driven boom in their cloud services. Their customers are the countless application software vendors that are currently launching new GenAI-driven SaaS products in mass quantities. Behind this are the various "AI co-pilots" that are now finding their way into many software applications.
The question that remains unanswered is how much additional revenue can be generated by these new GenAI products on the application software side. How much value do these AI assistants really add? What are consumers and especially companies willing to pay for these services? And will the efficiencies of AI ultimately lead to more software sold per workstation, but fewer employees licensed for it?
See the article on Nvidia Stock - When will the AI Bubble Burst?
I expect there will be a lot of disappointment in the GenAI apps from software providers in the next 1-2 years. This will ultimately have a negative impact on the business of Nvidia and cloud providers. The AI hype will end sooner or later - just like any other hype.
Google will be negatively affected by this as well. But to a much lesser extent than for example Nvidia, whose business development is much more directly based on these AI revenues.
The Valuation of Alphabet Stock
If you have been following this Substack for a while, you know that a reasonable valuation is fundamentally very important to me in any investment.
Valuation matters! This is often forgotten in the current AI hype.
Analysts repeatedly point out that Alphabet's valuation is average by historical standards, even near its historic highs. And indeed, the P/E ratio is below 25, which seems fair.
However, I believe that another approach to valuing a stock is much more important than the P/E ratio. I prefer the Enterprise Value to Free Cash Flow multiple. Based on this EV/FCF ratio, Alphabet's shares are more expensive than they have been in many years, with an EV/FCF of over 35. I would therefore advise against buying at the moment.
Conclusion
The Alphabet share, like Big Tech as a whole, has become expensive. As a result, I've reduced the Alphabet position in my investable model portfolio quite a bit recently, realizing over 300% profit.
However, I still think Google, YouTube and Waymo will be big players in the AI age, so I'm holding on to a smaller position in the Alphabet investment for now. I could also see myself adding to the Alphabet position again if there were to be a sharp correction in the market.
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*Disclaimer
The author and/or related persons or entities own shares of Alphabet. This post is an expression of opinion and not investment advice. Please note the legal information.
I agree that Alphabet is not a buy atm, but I wouldn’t sell either.