NVIDIA (NASDAQ: NVDA) The company has almost singlehandedly led the stock market to new highs this year. Maybe it’s an exaggeration, but it certainly feels that way. Investors have rushed to buy NVIDIA’s stock, recognizing how integral the semiconductor supplier is to the infrastructure and growth of artificial intelligence (AI) solutions. The company offers the best computing solutions for AI, and it wields incredible pricing power for its customers.
But what if I told you that another tech giant not only has a subsidiary like Nvidia, but is also the only company with the assets to vertically integrate the entire AI supply chain?
Enter the alphabet (Nasdaq: GOOG) (Nasdaq: GOOGL).
Yes, the owners of Google Search have the hardware, infrastructure, software, and engineering talent that they’ve spent a decade building that’s simply unmatched anywhere in AI technology today. Plus, the company’s stock is actually trading at a reasonable earnings multiple after falling 20% from its all-time high over the past few weeks.
If you missed out on Nvidia’s phenomenal gains, here’s why you should buy Alphabet stock.
Alphabet: The only vertically integrated company in AI
Nvidia has made graphic processing units (GPUs) a necessary component for building AI systems, but GPUs have been around long before AI became a hot topic. Inspired by these computer chips, Alphabet began investing in its own computer chip designs a decade ago. The company unveiled its first tensor processing unit (TPU) in 2015. The purpose of the TPU is to optimize Alphabet’s huge computing costs generated by Google Search, YouTube, and other consumer internet properties.
This computing hardware is currently advancing rapidly: The sixth generation of Trillium, launched this year, delivers a 4.7x increase in computing performance over previous TPU generations, a huge cost savings that Alphabet can implement into all new AI products.
TPUs are like Alphabet’s in-house Nvidia business, the backbone of the company’s AI computing. But they do more than just optimize chip performance. Alphabet also has a Google Cloud division, which of course includes TPUs and sells Alphabet’s AI capabilities to third parties. Google Cloud generated $10.3 billion in revenue last quarter, growing 29% year over year. With demand for AI on the rise, the division has a long way to go.
Of course, Alphabet also has a data advantage when it comes to training AI tools: Google Search, YouTube, and other Alphabet properties have billions of users around the world that can be used to train AI models. Because Alphabet’s datasets here are proprietary, OpenAI (the organization behind ChatGPT) could face legal challenges by scraping data from YouTube transcripts to train its own AI.
The story continues
Finally, Alphabet has the best AI talent in the world and has been investing in AI researchers since acquiring the DeepMind lab in 2014. Some competitors, such as Amazon with its cloud computing business, may be able to match Alphabet’s capabilities in parts of the AI supply chain. However, no other company can match Alphabet’s combination of computing technology, cloud infrastructure, data trove, and talent in AI. This is why Alphabet has a head start on winning AI this century.
That’s big growth, but at what cost?
It’s clear that demand for AI research and computing power is on the rise. But how will that translate to Alphabet’s bottom line and drive more profits for the company? During a conference call earlier this year, Alphabet CEO Sundar Pichai said the risk of underinvesting in AI is greater than the risk of overinvesting and wasting money. But shareholders hate wasting money, which is probably why the market has been bearish on Alphabet stock recently.
Management plans to spend tens of billions of dollars on capital investments in new AI capabilities across its various Internet properties. To get an adequate return on this invested capital (ROIC), Google will need to continue to grow revenue across its three main segments: Google Search, YouTube, and Google Cloud.
Last quarter, revenue from Google Search (which also includes other Google properties) grew 14% to $48.5 billion. YouTube advertising grew 13% to $8.7 billion. We mentioned Google Cloud above. So far, Alphabet is doing well in the AI era. However, investors should keep a close eye on revenue growth. If Alphabet spends too much on AI infrastructure and revenue growth slows, profits could decline. The P&L math is right on the money.
This stock seems like a good buy
After a recent sell-off in its stock price, Alphabet is now trading at just 23 times earnings, well below other tech peers such as Apple, which trades at 33 times earnings but is growing more slowly. The broader S&P 500 index trades at a P/E closer to 29 times.
For believers in Alphabet’s AI dominance, the stock looks like a bargain right now. Revenue growth in its cloud, YouTube, and Google Search segments should translate into solid earnings. Meanwhile, management continues to buy back shares and just announced a new dividend that will boost returns to shareholders.
At current levels, there’s a lot to like about Alphabet stock, and if you want to bet on the growth of AI, I’d buy this stock now.
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John Mackey, former CEO of Amazon subsidiary Whole Foods Market, serves on The Motley Fool’s board of directors. Suzanne Frey, an Alphabet executive, serves on The Motley Fool’s board of directors. Brett Schafer has invested in Alphabet and Amazon. The Motley Fool has invested in and recommends Alphabet, Amazon, Apple and Nvidia. The Motley Fool has a disclosure policy.
Missed out on Nvidia’s huge gains? Buy these AI stocks instead was originally published by The Motley Fool.
