Google-parent Alphabet has been in a bad shape last year. There are many reasons to believe that its stock still has room to run, despite concerns about its AI spending.
Last summer, the company was caught in an antitrust investigation and faces questions about its dominance in search ads. The threat that OpenAI’s ChatGPT could take over search traffic and erode more than 90% of its market share seemed real. Google had not established itself as a force in AI. Some analysts also suggested that the company would be worth more if it broke up.
A year later, it’s mostly due to the company’s antitrust troubles. The threat of discovery turned out to be exaggerated. Alphabet’s moves to protect the franchises that supply more than half of its revenue have worked. The cherry on top: This AI has gone from lagging behind to vying for the leadership role.
Alphabet’s stock has surged more than 80% in the past year, enough to make it the world’s third-most valuable public company, behind Nvidia and Apple. This has pushed its price up to almost 25 times forward earnings – a relatively rich valuation to be sure. But this is difficult considering the growth prospects of the company.
They were evident in Alphabet’s quarterly earnings on Wednesday. These included 24% revenue growth and rising sales at its cloud-computing unit.
Of course, there are still challenges. Markets were disappointed on Wednesday after Alphabet raised guidance for capital spending this year from $15 billion to about $200 billion and suggested a larger sum would be available for next year. According to FactSet, analysts expect capital spending of $257 billion in 2027 – more than Amazon, Meta or Microsoft.
If the consensus estimates are correct, it would make Alphabet’s free cash flow nearly negative. But that also means it probably won’t be the first company to blink at AI spending. This should help it remain technically competitive – especially if rivals are forced to apply the brakes.
Alphabet has also lagged a bit behind in the race to create the most advanced, most capable AI models. Its cutting-edge Gemini 3.5 Pro model has been delayed by several weeks after the company initially said it would be available in June.
Delays are bad news in the AI world. Those left behind often struggle to catch up, as competitors remain stagnant. Meta platforms have recently learned this lesson.
But the delay is unlikely to have that bad an impact on Alphabet. Unlike Meta, it has a large base of corporate AI customers who will not move due to a short delay.
And corporate customers are flocking to Alphabet, not running away. Chief Executive Sundar Pichai said earlier this year that the company’s Gemini Enterprise — a cloud-based AI service for companies — had a 40% quarter-on-quarter increase in paid active users in the first quarter.
This delay doesn’t help Alphabet’s ambition to provide cutting-edge AI-coding tools – the area where its AI strategy is most lacking. But there are many parts of a company’s business where having a world-leading model is not important.
The company has recently focused on releasing more efficient models. This will help AI tools like Gemini chatbot generate quicker responses and conserve computing resources.
This is a smart move when competition is fierce, both inside the company and among customers to provide computing power to AI. At this stage, generating quick responses to attract and retain users may be as important as a super-advanced AI model.
Other aspects of Alphabet’s business look healthy.
Ad spend is resilient, and the AI overview Google has added to its search engine is driving traffic. Analysts at BMO Capital Markets expect revenue from Google’s search business to generate double-digit quarterly growth for at least the rest of the year. The company said Wednesday that search revenue grew 17% in the second quarter.
Perhaps even more promising is that the company is rapidly moving into cloud computing. Alphabet said Wednesday that cloud revenue rose 82% to $24.8 billion, and pointed to a $514 billion backlog driven by customers including Apple, Meta and Anthropic.
Google is also starting to sell its custom AI chips, called TPUs, to customers for use in their own data centers. The company expects this to lead to a significant increase in revenue from next year.
All this suggests that Alphabet is well positioned to gain cloud market share until AI-driven demand subsides. Leading cloud-computing company Amazon reported first-quarter revenue of $37.6 billion, an increase of just 28%. Microsoft’s cloud business, the industry’s second-largest, grew at a 40% pace in its latest reported quarter.
Plus, Alphabet is capturing that growth without breaking the bank. The company had $242 billion in cash and marketable securities on its balance sheet as of the second quarter, after raising about $60 billion from bond sales this year and about $85 billion in equity in June. While AI-linked bonds have not performed well recently amid concerns about their large supply, Google should have more room than its rivals to continue spending.
Alphabet’s stock has lagged the Nasdaq Composite index this year and declined in recent sessions amid news of AI delays. Bubbles but potentially momentary concerns about cheap Chinese AI models haven’t helped either.
Even though its stock may have momentarily fallen a notch, Alphabet’s growth prospects have hardly diminished.
Write to Asa Fitch at asa.fitch@wsj.com
