The Nasdaq Composite index has been in impressive form over the past year with gains of more than 18% thanks to the healthy rally in technology stocks that have benefited from catalysts such as artificial intelligence (AI), but the index has witnessed a pullback of late.
The Nasdaq Composite index is down over 10% in the past month as the market seems to be having doubts about AI’s ability to drive substantial growth for big tech companies. Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) is a casualty of this sell-off; its shares are trading down 12.5% since July 23 when it posted results that comfortably exceeded Wall Street’s expectations.
This could be an opportunity for investors to buy a top AI stock at an attractive valuation. Let’s look at the reasons why.
AI is accelerating Alphabet’s growth
Alphabet released its second-quarter 2024 results on July 23. The tech giant’s revenue increased 15% year over year in constant currency terms to $84.7 billion, which was a nice improvement over the 9% growth it reported in the same period last year. Alphabet’s adjusted earnings increased 31% year over year to $1.89 per share, driven by an increase of three percentage points in its operating margin.
Analysts were expecting Alphabet to deliver $1.85 per share in earnings on $84.2 billion in revenue, but it looks like the company’s aggressive capital spending has got investors worried. Alphabet’s capital spending increased from $6.9 billion in the same period last year to $13.2 billion last quarter, exceeding the $12.2 billion consensus estimate by a big margin.
Management points out that it expects to continue increasing its capital investments in 2024 to “support the growth of our business and our long-term initiatives, in particular in support of AI products and services.” It looks like investors wanted to see much stronger growth from Alphabet considering its aggressive capital investments to capitalize on the AI market’s growth. However, a closer look at some of the growth trends from Alphabet’s latest quarterly report indicates that the company is indeed benefiting from the proliferation of AI.
For instance, the company’s revenue from the Google Cloud business increased almost 29% year over year to $10.35 billion. Market research firm Canalys estimates that global spending on cloud infrastructure could increase by 20% in 2024. Alphabet, however, is recording faster growth in this segment. Google Cloud revenue was up 28% in the first quarter of 2024, and the company witnessed a slight uptick in this segment in Q2.
This strong showing by the Google Cloud business is not surprising, since the company’s AI infrastructure and large language models (LLMs) are gaining healthy traction among customers. This bodes well for Alphabet, as the demand for cloud-based AI infrastructure and services is expected to become a $397 billion market in 2030 as compared to $60 billion last year.
More importantly, Google Cloud revenue is growing at a faster pace than Alphabet’s overall revenue. So, the huge opportunity in the cloud AI market could eventually accelerate the company’s growth in the long run as Google Cloud starts moving the needle in a bigger way for this “Magnificent Seven” stock.
At the same time, Alphabet’s focus on integrating AI tools within its advertising business is also reaping rewards for the company. Its Google Advertising revenue was up 11% year over year in the previous quarter, a trend that’s likely to continue with the help of AI. Alphabet management pointed out on the latest earnings conference call that advertisers using its AI tools are witnessing an improvement in the quality of ad views and are benefiting from an improvement in conversion rates and profitability.
Not surprisingly, Alphabet has been aggressively rolling out AI-focused features for advertisers, delivering 30 such features in the previous quarter alone. Alphabet is doing the right thing by investing in AI-driven advertising features, since more than 90% of advertising is expected to be AI-enabled by 2029. So investors would do well to focus on the bigger picture because Alphabet could eventually clock faster growth in the long run, and AI is set to play a key role in driving the same.
The valuation makes buying Alphabet stock a no-brainer
We have seen that Alphabet delivered impressive bottom-line growth last quarter. The good part is that analysts expect its earnings to increase 32% in 2024 to $7.65 per share from $5.80 per share in 2023. More importantly, as the following chart shows, analysts raised their earnings growth expectations for Alphabet recently.
GOOG EPS Estimates for Current Fiscal Year data by YCharts
Alphabet stock currently trades at 24 times trailing earnings. That’s a discount to the Nasdaq-100‘s earnings multiple of 31. Investors, therefore, are getting a good deal on this AI stock following its latest drop, and they should consider grabbing this buying opportunity, as it seems capable of delivering long-term gains.
