Elevator Pitch
I assign a Buy rating to Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG), a company which is also referred to as Google.
My earlier write-up for Google published on February 10, 2023 touched on the four key investment considerations relating to Alphabet, namely "competitive pressures, regulatory headwinds, historical results and valuations."
In the current article, my focus is on Alphabet's long-term outlook, considering the growth potential of AI. I upgrade my rating on Google from a Hold to a Buy, given that I expect Alphabet to be able to deliver a pretty decent level of top-line growth for the next decade with AI-related tailwinds.
Alphabet Stock Key Metrics
The key metrics for Alphabet relate to the company's costs, investments, and search advertising business.
With respect to expense optimization, Google announced earlier in an 8-K filing released on January 20, 2023 that it will cut its "workforce by approximately 12,000 roles", or around 6% of its total number of employees. Alphabet is likely to have considered cost-cutting as a means of expanding its capacity to invest in Artificial Intelligence or AI. In this 8-K filing, Alphabet specifically mentioned that the company aims to "direct our talent and capital to our highest priorities", and noted the "substantial opportunity in front of us with AI."
With regards to competition, the threat posed by Microsoft's (MSFT) AI-powered Bing search engine doesn't seem as damaging as earlier feared.
A March 13, 2023 research report (not publicly available) titled "Alphabet: CFO Commentary On AI Suggests Products Are Coming" published by BofA (BAC) Securities highlighted that "Bing activity is not impacting Google Web traffic." The BofA report cited data from SimilarWeb, which showed that the number of visits to Google's website on a daily basis (averaging around 2.8 billion) was stable in the first month following MSFT's introduction of its new AI-powered Bing search engine on February 7.
Separately, Microsoft disclosed on March 8, 2023 that "one third of daily preview users (for Bing) are using Chat daily", which isn't as high a percentage as one would have expected given the buzz surrounding chatbots. In other words, there doesn't seem to have been a very meaningful change in search preferences from traditional search to AI chatbots for now.
A comparison of Alphabet's FY 2022 10-K and FY 2021 10-K filings also highlights certain key metrics.
In its FY 2021 10-K filing, Google highlighted that "we have invested more than $100 billion in R&D over the last five years", but this was taken out from the company's FY 2022 10-K filing. This implies that Alphabet is most probably going to exercise tight control over costs and investments in the very near term.
On the other hand, Alphabet included in its FY 2022 10-K filing additional descriptions about search and AI. Specifically, Google indicated in its most recent fiscal year 10-K that "of the searches we see every day, 15% are new", and emphasized that "AI already powers Google's core products that help billions of people every day." In my opinion, Alphabet is sending the message that Google will continue to be dominant in search, and the company is well-prepared to capitalize on the rise of AI.
In a nutshell, an analysis of Google's key metrics suggests that the company's prospects for both the short-term and long run should be good.
What Is The Short-Term Prediction?
Alphabet is expected to report its financial results for the first quarter of fiscal 2023 towards the end of this month, and my view is that Google's upcoming quarterly financial performance disclosure should meet the market's expectations.
In the past three months, Google's normalized EPS estimate for Q1 2023 have been lowered by 16 of the Wall Street analysts covering the company's shares. During this same time period, only three sell-side analysts raised Alphabet's first quarter and bottom-line forecasts, while the other analysts left their financial projections for the company unchanged. Specifically, the market consensus expects Alphabet's normalized EPS to decline by -13% to $1.07 in Q1 2023, which is worse than Google's -6% YoY bottom-line contraction for Q1 2022.
In other words, Wall Street has pretty modest expectations of Alphabet's Q1 2023 results. In the preceding section, I highlighted that Google's search business shouldn't have been affected in a meaningful way by MSFT's new AI-powered Bing search engine, and I also noted that Alphabet is putting a great emphasis on optimizing expenses and controlling the pace of new investments. The above-mentioned factors point to Alphabet's first quarter results coming in line with the sell-side's expectations at worst, which is my short-term prediction for the stock.
What Are Catalysts To Watch For?
There are two catalysts for Alphabet that are worth keeping an eye on.
The first potential catalyst is further layoffs.
Based on my analysis of Google's prior financial filings, Alphabet has increased its staff strength by more than 71,000 in the last three years. In comparison, the company has only announced 12,000 layoffs, or just under 17% of new headcount additions since end-2019, in January 2023. It is reasonable to expect Alphabet to announce plans for further workforce optimization in time to come, which will indicate to the market that Google is serious about preserving profitability in tough times.
The second potential catalyst is indicators or news flow suggesting that Google Search hasn't ceded ground in its battle with Microsoft's Bing.
Seeking Alpha News reported recently on April 6, 2023 that Alphabet "plans to integrate conversational artificial-intelligence features to the company's flagship search engine." This should help to ensure that Google Search is competitive with Microsoft's Bing, assuming that chatbots become much more popular with internet users going forward.
In an earlier section of this article, I have already cited certain statistics on Google's search traffic and Bing's user engagement which suggest that Microsoft's Bing hasn't gained much ground on Google Search. Looking ahead, Google search advertising revenue trend in subsequent quarters, and other user search metrics disclosed by Alphabet and Microsoft will most probably help to validate the thesis that MSFT's Bing isn't impacting Google's search advertising business in a big way.
Where Will Google Stock Be In 10 Years?
In the next decade, Alphabet should deliver faster revenue growth than what the market currently expects, thanks to AI-related growth opportunities for Google Search and Google Cloud.
The sell-side sees Google's revenue growing by a 10-year CAGR of +8.5% from $282.8 billion in FY 2022 to $641.9 billion for FY 2032. If Alphabet's actual top-line growth for the coming decade turns out to be better than what the analysts are predicting, the company's stock price performance going forward should be pretty favorable. With AI recently emerging as a key investment theme following the launch of ChatGPT, it is natural that analysts and investors haven't fully factored in the growth potential of AI into Alphabet's forward-looking numbers.
At the Morgan Stanley (MS) on March 8, 2023, Google stressed that it has "used AI that really help advertisers achieve and maximize their objectives around ROI (Return on Investment)" with search ads. Alphabet also noted at MS' investor event in early March that its Google Cloud Platform's or GCP's "AI infrastructure enables customers really to leverage TPUs (Tensor Processing Units), GPUs (Graphics Processing Units) to really run what they need."
As per the company's management comments at MS' TMT conference on March 8, Alphabet wants to leverage on AI to achieve higher ROI on its search ads. It means that Google search will become more effective with the support of AI, and drive an increase in click-through rates or CTR. This should in turn lead to higher cost-per-click or CPC, and accelerated Search revenue growth for Alphabet in the long run.
Separately, a February 2023 research study conducted by Global Market Insights forecasted that the size of the worldwide public cloud market will expand from $400 billion last year to in excess of $1 trillion by 2032. In Global Market Insights' report, the "mounting deployment of AI" is cited as one of the key growth drivers for the public cloud market. As one of the leading cloud players alongside Amazon's (AMZN) AWS and Microsoft's Azure, Google Cloud Platform or GCP is in a good position to benefit from additional top-line contribution associated with an increase in cloud AI spend.
Is Google Stock A Good Long-Term Investment?
Alphabet is an appealing investment candidate for the long run, which warrants a Buy rating. The rise of AI should allow Alphabet's key businesses like Google Search Advertising and Google Cloud Platform to grow at a faster pace in the coming decade. In terms of valuations, Alphabet's current consensus forward next twelve months' EV/EBITDA multiple is 11.3 times (source: S&P Capital IQ). Google's valuations are attractive for a company which is expected to grow its revenue by a CAGR of above +10% in the next 10 years and has achieved strong operating profitability (i.e. FY 2018-2022 EBITDA margins in the 35%-40% range) for years. Undemanding valuations and better-than-expected growth prospects for the long run make Google a good long-term investment.
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