Alphabet just said checkmate to Microsoft, but here’s why investors could be the real winners

By | December 20, 2023

A person using a chatbot

Financial headlines about artificial intelligence (AI) dominated 2023, with the ‘Magnificent Seven’ stocks of Microsoft, Alphabet (NASDAQ: GOOG)(NASDAQ: GOOGL), Apple, Tesla, Metaplatforms, AmazonAnd Nvidia attract the most attention.

Microsoft started the AI ​​arms race after investing $10 billion in OpenAI, the developer of ChatGPT. Not long after, Alphabet debuted its own large language model (LLM), called Bard. Let’s just say that Bard’s initial response was disappointing, as the chatbot didn’t exactly provide accurate answers to basic questions during the public reveal.

Nevertheless, as ChatGPT rose to public attention, Alphabet doubled down and kept working. Earlier this month, Alphabet unveiled its latest entry into generative AI, called Gemini.

Make no mistake: Alphabet’s Gemini release is a calculated chess move during otherwise tumultuous times at OpenAI and the potential consequences for Microsoft. Could this now be a buying opportunity for Alphabet stock before the company starts reaping the benefits of its new AI product?

Is Gemini better than ChatGPT?

If you’re wondering if Alphabet just skipped Microsoft and asked which generative AI application is more powerful, welcome to the club. This is literally the billion dollar question. According to research by Goldman SachsGenerative AI has the potential to increase gross domestic product (GDP) by $7 trillion over the next decade – a theme that is generating a lot of interest on Wall Street.

A few months ago it was announced that famed hedge fund manager Bill Ackman had taken a significant stake in Alphabet. During a fireside chat with CNBC’s Scott Wapner, Ackman talked about his bullish position on Alphabet. The bottom line is that Ackman is attracted to Alphabet’s ecosystem, which comes from Google Search, productivity applications like Gmail, video website YouTube and the company’s growing cloud business. According to him, Alphabet is uniquely positioned to integrate artificial intelligence into its entire range of services, making it invaluable to end users.

The obvious undercurrent of Gemini is that it could further boost demand for Alphabet’s various products, making it appear lucrative and validating Ackman’s hypothesis. But I would caution investors to zoom out and really look at the full picture here.

Like Alphabet, Microsoft also has an attractive ecosystem. According to the company’s latest earnings report, Microsoft experienced more demand for its AI applications than expected. And while OpenAI has helped drive growth in Microsoft’s Azure cloud segment, the real opportunities may be just beginning.

Given the tailwinds pushing both Alphabet and Microsoft, I think it’s still a bit early to label one generative AI application as superior. For investors seriously considering a position in Alphabet, analysis beyond the AI ​​potential is needed.

A finger points to a screen with a chatbot.A finger points to a screen with a chatbot.

Image source: Getty Images.

Alphabet’s valuation looks very attractive

There are several ways to rate a stock when it comes to valuation. One measure that can be useful is to look at a company’s future price-to-earnings (P/E) ratio, compared to a range of comparable companies.

GOOG PE ratio (forward) chartGOOG PE ratio (forward) chart

The chart above illustrates that Alphabet’s price-to-earnings ratio of 23 is the lowest among its Magnificent Seven cohorts. Note that Microsoft’s price-to-earnings ratio of 33 is well above Alphabet’s, indicating that the markets are applying a premium to the Windows developer.

The chart below goes beyond the forward price-to-earnings ratio and illustrates the company’s price to free cash flow ratio over the past ten years. At a multiple of 22.4, Alphabet shares are trading at a huge discount to the 10-year average, and quite close to the low of 18.1. This appears to be yet another sign that markets are discounting Alphabet stock and its robust business model. It is the company’s consistent free cash flow generation that gives Alphabet the financial flexibility to invest in new growth areas such as AI.

GOOG Price to Free Cash Flow ChartGOOG Price to Free Cash Flow Chart

Should You Buy Alphabet Stock?

Alphabet’s shares look quite cheap at current trading levels, especially compared to the competition. The secular tailwinds that artificial intelligence is fueling, coupled with the company’s institutional support, are reasons to be optimistic. However, given the company’s massive dominance in its core online advertising business and its contribution to helping fund other growth engines such as cloud and AI, this does not seem to be appreciated. This most likely stems from the fact that some believe ChatGPT will replace Google Search, leaving Alphabet in an existential crisis.

If the valuation analysis above is anything to go by, it could imply that the claim that Microsoft will dethrone Alphabet in online search results is short-sighted. Since Alphabet is home to the two most visited websites in the world (Google and YouTube), advertisers are eager to leverage these platforms. And with 2024 marking the start of a new election cycle, research suggests this could be a record year for political advertising campaigns – a theme that should benefit Alphabet greatly.

Moreover, it is clear that the addressable market for artificial intelligence is not only large, but still developing. As applications and use cases multiply, there will likely be multiple winners. With the stock trading at historically low levels, this could be a unique opportunity to start calculating dollar costs in Alphabet. Both the short and long term look good, and investors should take advantage of the discounted trading multiples now.

Should you invest €1,000 in Alphabet now?

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Suzanne Frey, a director at Alphabet, is a member of The Motley Fool’s board of directors. Randi Zuckerberg, former director of market development and spokeswoman for Facebook and sister of Mark Zuckerberg, CEO of Meta Platforms, is a member of The Motley Fool’s board of directors. Adam Spatacco has positions in Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla. The Motley Fool holds positions in and recommends Alphabet, Amazon, Apple, Goldman Sachs Group, Meta Platforms, Microsoft, Nvidia, and Tesla. The Motley Fool has a disclosure policy.

Alphabet Just Said “Checkmate” to Microsoft, But Here’s Why Investors Could Be the Real Winners originally published by The Motley Fool

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