Alphabet (GOOG, Financial)(GOOGL, Financial) stock found itself in bear territory last week after Google's AI bot Bard answered a query incorrectly. Alphabet, the parent of Google and several other former Google subsidiaries, lost $100 billion in market value on Wednesday, and several analysts are raising questions regarding the company's ability to compete in terms of AI against other players like Microsoft (MSFT, Financial).
However, it is essential to look at Alphabet's entire business to assess it value properly, not just one industry that is still very early in the development stages.
Due to the size of the enterprise and its solid profitability, Alphabet possesses a key advantage in the AI race. The company's profits in 2022 were $59.98 billion, or $4.56 per share. Alphabet is making an incredible $5 billion monthly profit, far outstripping expenses.
Plus, although Bard messed up, it's important to understand that the AI industry is still in its early stages, and Alphabet is investing heavily in developing it. In the future, this could help diversify Alphabet's revenue from advertising.
The stock rarely trades at a discount, as investors are willing to pay premium prices for Alphabet's moat. Temporary setbacks are an ideal time to add more of this name to one's portfolio.
Strong financials
Alphabet Inc. is the parent company of Google and its other subsidiaries. It was formed as a new corporate entity in 2015 by Google founders Larry Page and Sergey Brin to make Google's core business operations more transparent. Since then, Alphabet has become one of the world's most valuable companies and a major player in the tech industry.
Alphabet owns many well-known businesses, including Google Search, YouTube, Android, Chrome OS, Nest Labs and Waymo. Through these businesses, Alphabet provides a variety of products and services that billions of people use worldwide. Through its groundbreaking technologies and products, Alphabet has secured a major foothold in multiple industries, though the main source of its revenue is one and the same: advertising.
As a result of its search market dominance and astute monetization, Alphabet has a strong balance sheet. At the end of last year, Alphabet had $113.76 billion in liquid assets and $27.20 billion in debt, resulting in a net cash position of $86.56 billion, or $6.75 per share. Such financial health is rare and allows Alphabet to pursue moonshot opportunities such as its AI chatbot.
Bard stumbles
The Bard launch was far from satisfactory and caused Alphabet's stock price to plunge, resulting in an immense decrease in market capitalization.
As of late, AI chatbots have been a major focus in the news sphere after OpenAI's ChatGPT took the world by storm. ChatGPT has become incredibly popular since it was released for public use, demonstrating the ability to create text that sounds like real human speech (even if it does sometime spit out facts that are confusing, contradictory or just downright wrong).
The market's reaction to Bard's wrong answer in the demonstration might seem to suggest that Alphabet is lagging behind Microsoft, which has already invested in OpenAI to integrate ChatGPT. Perhaps Google might even lose market share to Bing given its integration of ChatGPT, which would cut into Alphabet's main revenue source.
However, it's too soon to tell the impact and potential of AI technology. Moreover, even ChatGPT gets things wrong at times.
Heavy investment in AI
AI has become an integral part of our lives, and its impact will only increase. AI has the potential to revolutionize every sector of our society, from health care to finance, agriculture and education. AI is already used in many industries to automate processes and improve efficiency.
Statista estimates that the AI software market is set to skyrocket soon and could reach close to $126 billion by 2025. Newer areas of AI, which include natural language processing (NLP), robotic process automation (RPA) and machine learning, are driving this growth.
Alphabet understands this, which is why it invests heavily in this area. For example, Google is investing $300 million in a "generative AI" startup, Anthropic. The investment is for 10% of the stake to help the startup to move forward. Generative AI is an algorithm that can help create content like text, images and videos. Before Google's investment, Anthropic raised $700 million.
Furthermore, despite the initial hiccups with Google's new AI chatbot tool, it is not all doom and gloom. Alphabet will learn from this painful experience. The enthusiastic response to ChatGPT highlights the potential for AI-boosted search capabilities and answers that offer more than just a link. Also, it's important to note that AI has already been used in search algorithms for years, so the buzz around AI chat bots is mainly about improving and building upon that experience.
Google Ads are the main component of Alphabet's revenue stream, accounting for more than 80% of the company's total income. Despite attempts to increase revenue from other sources, advertising still contributes the bulk of the income. This makes it necessary for the organization not to let its focus on ad revenue slip.
The recent layoffs at Google are also a result of this focus on AI. The company is looking to free up resources for its AI ambitions by streamlining operations.
Bard botch is not the only reason Alphabet stock is down
Investors have been concerned about Alphabet's stock due to various factors. The issues with Bard are one major weakness factor, but that is not the only reason the stock is down almost 23% in the last six months.
One reason is Alphabet's fourth-quarter performance, which was less than impressive. It was not that earnings came short of analyst estimates that peeved investors. Rather, the major issue was the decline in ad revenue. Revenues for the quarter were up 1% to $76.05 billion; however, advertising revenues declined by 3.6%.
During the fiscal first quarter of 2023, the company will likely incur costs that may lead to a drop in its overall profitability. There'll be a considerable amount of money going into severance pay and other exit costs related to downsizing. The company is expecting to dish out anything between $1.9 billion to $2.3 billion on the former and an additional $500 million for the latter.
On Jan. 24, the U.S. Justice Department filed its second antitrust action against Google in just over two years. The lawsuit relates to the company's monopolistic practices in online advertising, one of its primary sources of income. The DOJ believes that Google is involved from multiple sides of the market in advertising, and its position allows it to bypass merits and set the rules of business. Google is accused of benefitting from its monopoly position, leaving advertisers and the website creators at a disadvantage.
Takeaway
Alphabet has seen its stock drop due to a variety of factors. However, I believe the markets have already priced in these issues, which could make the stock undervalued at current levels. The GF Value chart agrees with this assessment, rating the stock as modestly undervalued.
