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ALPHABET: PUSHING
THE BOUNDARIES
With capital spending of close to US$50 billion this year alone, global technology giant Alphabet Inc. is ramping up its investment in artificial intelligence (AI). While the tech titan’s capital outlays appear enormous, in our view they will be justified given the opportunity to exploit ongoing strength in both core Search as well as nascent industries like Google Cloud offerings. As one of our biggest holdings in the field of AI, we remain positive about the company’s prospects.
Alphabet’s 2024 first-quarter results illustrate how much growth has picked up from a year ago. In the quarter, total revenue increased 15% year over year, with Search advertising increasing 14% as online retailers, including those based in Asia, drive growth. YouTube advertising surged 21%, which management attributed to rapid improvement in the monetisation of Shorts (videos), in addition to usage growth. While Microsoft’s Bing is attempting to dethrone Google with AI technology from OpenAI, we think the firm can defend its dominance in Search with its own AI technology, some of which OpenAI’s products are based on.
The Cloud business also delivered impressive growth, with revenue up 28%, the best result in more than a year, as AI use cases augmented growth in the compute and Workspace productivity businesses. Google has quickly leveraged the technological expertise applied to its private cloud platform to expand into the public cloud business. The firm has increased its market share in this area, driving additional revenue growth and creating more operating leverage.
Alphabet recently introduced enhanced features within its Search business, where it has been an AI leader and innovator for some years now. Its Gemini technology continues to push the boundaries of internet search, serving as an advanced tool for both consumers and business users.
The company has successfully and consistently monetised many of its technology-based intangible assets, from the original algorithms behind Search to the current machine-learning ones and deep learning-based generative AI (gen AI) technologies, which are being applied to nearly every product. While gen AI creates uncertainty in Search, we expect that the size of Google’s revenue opportunity will remain intact.
For advertisers, value is created mainly through growth of the large user base and from compiled and analysed behavioural data. As users and search requests grow and more data is gathered, advertisers’ demands for ads increase, helping Google to further monetise the network. With regard to YouTube, the site benefits from a network effect that creates value for users, content creators and advertisers. With more viewers on the site today, more content creators look to YouTube for content distribution. YouTube’s video platform has more viewers than other online video properties, making it attractive for advertisers.
While Alphabet is not the first tech company to commercialise its generative AI capabilities, we consider Google a front-runner in AI. Generative pre-trained transformers, or GPT, the technology created by OpenAI and used by Microsoft Bing, is based on an architecture developed by Google in 2017, which is now widely used by other AI technology providers.
Alphabet also continues to invest in various high-risk projects with high potential rewards, which, if successful, could generate significant returns. Investment in autonomous vehicle technology (Waymo) is just one example. It appears that management is aiming to remain ahead of the pack by acquiring valuable assets to utilise and build on, as it did with Android, YouTube, DoubleClick, AdMob, Motorola Mobility, Looker and Fitbit.
Recently, Alphabet demonstrated its AI leadership with more than 30 new products across five categories, including Search, Shopping and YouTube. One example is its new gen AI digital assistant. This tool will enable users who use AI Overviews to use Search more and enjoy deeper levels of engagement. AI Overviews is an experiment in Search Labs that lets you see AI Overviews on more Google searches and offers access to additional generative AI features in Search. Gen AI helps users find answers, regardless of how specific the question is.
As a result, over the past six months, the volume of searches with five or more words grew 1.5 times faster than shorter queries. Greater context in the Search bar means that links are surfaced to a more qualified and engaged audience. With gen AI, Alphabet is facilitating new ways to search that extend beyond text. The company is now seeing around 12 billion visual searches per month using Google Lens (one in four visual search queries using Google Lens have commercial intent) and plans to launch Search with video soon. These modalities, coupled with new products like Circle to Search, are growing the use cases and monetisation opportunities that Search addresses.
Alphabet’s share price has moved to a new high and continues to outperform the global equity market. It’s important that we don’t get fixated on share price moves, however, and rather consider whether the new highs are justified. As can be seen on the graph below, the impressive earnings growth is clearly fundamental to the ongoing strength in the share price.
It should be noted that after the latest results announcement, earnings estimates have moved up for Alphabet as the market discounts a sustained pickup in its core Search business. The valuation is in line with the seven-year average levels and we believe the share is fully valued at current levels. If Alphabet continues on its path of impressive market-beating earnings growth, the intrinsic value will keep growing.
At the risk of repeating our ongoing enthusiasm for Alphabet, we remain positive about this company’s prospects. In our view, Alphabet’s unparalleled technology platform and opportunities in multiple compelling growth verticals will enable it to generate free cash flow growth in the high single digits over the next decade.
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