Shares of Alphabet fell from near all-time highs after the company reported fourth quarter earnings. The results were quite good, revenue growth accelerated at the fastest pace in six quarters and profitability was above expectations. However, management noted capital spending would be “notably larger” in 2024 and failed to give meaningful detail about reducing its cost structure.
It’s interesting that shares recently reached new highs given controversial investor sentiment surrounding the company. While optimism is primarily fueled by the prospects of digital advertising, Google’s core business, it’s controversial because the company is perceived to be catching up in the world of artificial intelligence. Yet, Alphabet is actually a leader in the field of AI. Having acquired DeepMind Technologies a decade ago, the company has consistently invested in this space ever since. Its latest advancement, Gemini, is a powerful multimodal AI model – capable of comprehending different types of information such as text, code, audio, images, and video. Notably, Gemini benchmarks higher than OpenAI’s ChatGPT in several aspects, though clear measurement standards have not been established. Despite challenges from Apple’s privacy changes and a post-pandemic digital ad malaise, Google’s ad business has fully recovered. In fact, over the past five years, global interactions with Google have more than doubled. With the promising benefits AI holds, Alphabet’s business is poised to become even more attractive in coming years.
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Google’s core search and advertising business stands to reap substantial benefit from artificial intelligence. Google’s fundamental mission is to organize the world’s information, which it can do far more effectively with Gemini. The ongoing competition among major tech players for dominance in the cloud, where much of AI implementation occurs, has witnessed Microsoft and Amazon take the initial lead. Indeed, a big reason the stock fell is management is ramping up spending to stay relevant in cloud. However, the improvement in capabilities artificial intelligence could deliver for Google should meaningfully accelerate growth and dramatically improve profitability of its main business. Oh by the way, YouTube generates more revenue and is growing faster than Netflix! YouTube is also an advertising business and Gemini will give content creators the power to create at a scale and quality that previously would have required a Hollywood movie studio.
Even with a step up in capital spending in 2024, the company is expected to generate over $80 billion in free cash flow. Over the next five years, analysts expect Alphabet’s annual cash flow will more than double. Sporting a $1.7 trillion valuation, the stock trades at 21x this year’s free cash flow – that’s a lower multiple than Coca Cola, Walmart, or Visa – but with faster growth. Investors will continue to debate Alphabet’s role in artificial intelligence, but the outlook for its core business couldn’t be brighter.
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