Google's Antitrust Battle and Market Outlook: Balancing Risks and Opportunities

DOJ V. Google On Ads: Lower Returns Hang In The Balance (NASDAQ:GOOGL)

I last covered Alphabet Inc. aka Google (NASDAQ:GOOGL, NASDAQ:GOOG) in August; I put out a Buy rating on a favorable valuation, outlining its significant strengths in offering low volatility compared to other big tech investments like Amazon (AMZN) and Tesla (TSLA). Since my article, the stock has fallen nearly 9.5% in price. On a pure valuation front, this creates a further buying opportunity, in my opinion. However, now there is a significant operational development whereby the largest revenue generator of Google hangs in the balance. On the day I write this, Alphabet will be defending itself against the U.S. Department of Justice (DOJ) on claims that it illegally operates an advertising monopoly. During this trial, questions of divestiture continue to circulate in the press. However, with a more moderate regulatory restriction outcome likely, I still consider Google stock a Buy. The lawsuit against Google stems from allegations that the company has engaged in a "systematic campaign to seize control" of the online advertising business. The DOJ is arguing that Google's dominance has been achieved through strategic acquisitions, including the purchase of DoubleClick in 2008, which led to increased switching costs for users and greater integration for Google. The DOJ is also focusing on Google's vertically integrated approach to the digital advertising supply chain, including its ad exchange and its ad server. The claim is that Google has forced market participants to use its products and has leveraged its position to disadvantage competitors. The scrutiny is certainly justified, as Google holds approximately a 90% market share of the global search engine industry; this dominance is foundational to its leading position in ad tech. Already in August 2024, a judge ruled that Google maintained an illegal monopoly in the Internet search market. The key element that, I believe, is important and shows why such scrutiny of Google is justified is that the DOJ claims that Google's practices have inflated costs for advertisers and restricted revenue for publishers. The result of this is less innovation and reduced choices in the market. This is a valid concern. It comes much needed at a time when big tech is expanding rapidly, but the average consumer and small and medium-sized businesses ((SMBs)) are struggling with high inflation, high interest rates, and fears of a broader non-tech-based Western recession. The most significant outcome here would be Google's forced divestiture of critical components of its ad tech business, such as the Google Ad Manager suite. This would significantly disrupt its vertical integration, dismantling its ad tech stack, and meaning it loses its ability to offer its fully integrated ad and publishing platform. The Google Ad Manager suite is a substantial revenue generator. In the latest quarter, Google's Network business, including the GAM suite, recorded $7.44B in revenue. It is worth noting that Google's overall advertising revenue, which totaled $64.62B in Q2, accounted for approximately 76.3% of Google's total revenue. In other words, Google is being attacked where it hurts. Even if the outcome of the advertising trial against Google is not negative, I believe Google will still likely be curbing its strategies for domination in its core markets following this trial. I find it unlikely that Google's leadership will continue with the same velocity as before in an attempt to moderate the scrutiny received by the DOJ at this time. It is also arguably the right call of action to show restraint on engendering monopoly at a time of hardship for smaller businesses. By slowing its rate of expansion and strategic consolidation, Google may be able to foster a healthier advertising ecosystem and increase the number of its advertising customers rather than put pressure on pricing. Therefore, I believe Google shareholders can expect a short-term loss here but overall a long-term gain, both for Google and the broader technology and SMB ecosystem, most of which depend on Google for internet relevance. Google is already known as a slow and steady company; however, we might expect it to be slightly slower from here on out. Its current trials come at a time when the DOJ and the Federal Trade Commission (FTC) have been actively pursuing antitrust cases against other major tech companies, such as Apple (AAPL) and Meta Platforms (META); in 2023, the FTC, along with 17 states, also filed a lawsuit against Amazon, alleging monopolistic practices. Furthermore, the EU's Digital Markets Act came into effect in March 2024. It targets major tech companies, including Google, Apple, Amazon, Meta, Microsoft (MSFT) and TikTok, which have been designated as "gatekeepers" and must comply with new regulations for fair competition in the digital markets. Continued scrutiny, any divestitures, and a broader breakup of its key operating arms are likely to strain Google's margins. This will primarily be the result of the fact that it is likely to lose pricing power from greater competition in the ad tech market. Google could also face substantial fines and legal costs if it is found guilty of antitrust violations, directly reducing its net income and profit margins. The scrutiny over its advertising and search business might also cause the company to divert resources toward less provocative operations, like its growing position in AI. The issue with this strategy is that AI regulations are likely to intensify over the coming years, and its Gemini and other AI projects are far less of a revenue generator than its ad business. As I mentioned, Google is not the only tech company going through this, but I believe the DOJ and the United States government are warning big tech to slow down in many respects. With a broader economy that is suffering from high prices, lowered demand, and a weakening jobs market, the big tech growth position is rightly being questioned. This is especially true during this time of high AI and automation investing, which should continue to be accretive to the magnificent seven, but arguably leave many SMBs worse off. Google is much more attractively valued than three months ago, when it was selling 13.8% higher in price. I mentioned in my last analysis of Google that it was approximately fairly valued at the time; now, it is likely moderately undervalued, although I believe we could see more of a price decline following the ruling by the DOJ. That being said, I believe the decline will be temporary and purely based on sentiment, with only moderate financial implications for Google in the near term, even in the case of a negative DOJ ruling. I consider any near-term downside that occurs in Google stock over the coming quarters from this, and also from a more general slowdown in revenue, primarily related to peak growth from AI tapering, as excellent long-term buying opportunities. Google has a P/E ratio that is almost half that of Amazon and far below Nvidia's (NVDA) P/E ratio of 50. Given that Google is expected on consensus to deliver YoY normalized EPS growth of 14% in calendar 2025, Amazon 22.70%, and Nvidia 40.50%, such disparity is justified. However, with Nvidia estimated to achieve a much lower calendar 2026 normalized EPS growth of just 18%, one can expect much better value and much less future volatility from Google at this time. Despite the DOJ trials that Google has faced recently being incredibly significant, they are not enough and are also not intended to impact the long-term growth trajectory of Google. In a worst-case scenario where significant portions of Google's advertising and search business are forced to be divested by the DOJ, we can expect a significant drawdown in Google's valuation multiples and stock price. This would be as a result of a decline in its total revenue under its stock ticker. I believe a heavy divestiture requirement from the DOJ is unlikely and also not favorable to the United States and West, with Google acting as one of the leading capital allocators and pioneers in the digital ecosystem. I expect we are to see potentially moderate fines and regulatory restrictions, including focusing on the exclusionary agreements that Google has with device manufacturers like Apple. Therefore, a significant drawdown is unlikely, but a slight to moderate one is, and this opens up a further buying opportunity. This ruling is not focused on one of Alphabet's core future operational drivers, which will be AI, and I expect a lot from this in the upcoming decades. As a result of my valuation analysis and the unlikelihood of a divestiture requirement, I consider Google a Buy. If, in 12 months, it trades at a P/E ratio of 21.5 and prices at the current FY25 GAAP EPS consensus estimate of $8.72, the stock will be worth $187.50. This indicates a 12-month upside of 25.30%. Based on my analysis, the current DOJ trials against Google are being slightly overexaggerated in the press. The likelihood of divestiture requirements here is slim, and instead, the regulatory restrictions and fines are much needed, especially during this period when the average SMB in America is struggling. Some more balance in the tech ecosystem is needed and deserved. Google may deliver slower growth than if it were left to operate unabated, but this is likely a short-term contraction for a long-term benefit, both for Google and the wider Western and global economy. Google is currently fairly valued, with a protracted drawdown unlikely and continued growth on the horizon. Therefore, Google stock is a Buy.

Google Stock Looks Tempting Already (Upgrade) (NASDAQ:GOOGL)

My coverage of Alphabet Inc. (NASDAQ:GOOGL) (NASDAQ:GOOG) (NEOE:GOOG:CA) stock was initiated here on Seeking Alpha back in November 2022. I initially had issued a neutral rating, and for the past 5 articles, I maintained it, pointing out that Google's launch of Gemini, a large language model for AI applications, should challenge Microsoft's (MSFT) "AI monopoly" and could boost Google's projected EPS figures in the medium term, but the valuation seemed too hot for me to touch. Since my last update on Google, the stock price has cooled significantly and has underperformed the broad market many times over: Despite the current market pessimism regarding Google's potential return on investment from its increased AI-related capital expenditure, I believe the stock is already attractive at its current levels. Although GOOG could fall further, I think investors might consider initiating a starter position. Therefore, I'm upgrading GOOG from "Hold" to "Buy". First off, let me address the primary factors likely driving Google's stock downward at the moment. I see two main reasons: 1) the ongoing antitrust case and 2) concerns about Google's return on investment from its AI-related capital expenditures. On January 24, 2023, the US DOJ brought an antitrust suit against Google accusing the firm for illegally monopolizing the advertising technology (adtech) market "in violation of sections 1 and 2 of the Sherman Antitrust Act of 1890." As Seeking Alpha recently reported, a victory for DOJ would "set the stage for them to ask U.S. District Judge Leonie Brinkema to order a breakup of the company", which is a huge risk for shareholders, as you can imagine. The company is expected to appear for the trial next week, but some analysts have already calculated the potential financial impact Google could receive after the trial. Here's a quote of analysts from J.P. Morgan (proprietary source) I found: We think the judge could require additional remedies to increase competition in the general search and text ad markets, such as Google providing patents or data for competitors to train on, though privacy should be a concern. While there is a wide range of outcomes across multiple variables, based on our scenario & sensitivity analysis we now believe Google is most likely to see up to 10% negative impact on its EPS, w/further (though less likely) downside scenario to 20% negative impact. But they add that the in the base case scenario, the net negative impact on EPS for FY2026 would be in the range of 3-7%: If we assume Google loses 10% share across Apple, third-party browsers, Android, & Chrome, and the TAC paid to Apple decreases by 10%, Google could see a 3% headwind to its 2026E GAAP EPS if changes apply only in the US and a 7% headwind if changes apply worldwide. In a further downside scenario in which Google could lose 25% share across distribution partners, EPS headwind could be 9%-21%. The net impact of 3-7% on earnings per share in 2 years is not a particularly strong shock in my opinion, which may explain the off-high of already over 20% that we see in GOOG stock: Another concern is the growing opinion that the massive investments the company has planned for the coming years in developing solutions to grow its business may ultimately prove unprofitable, making the stock overpriced as of today. The overvaluation was the primary reason for my downgrade a few months ago. I will revisit this point shortly, but for now, let's examine how the company performed in its most recent financial quarter. Having made over $84.7 billion in sales and generated $1.89 in earnings per share in Q2 FY2024, Google marginally beat the consensus forecasts last quarter - by 0.53% and 2.54%, respectively (Seeking Alpha Premium data). As you could see from App Economy's chart above, Google's advertising revenue, which is the primary income source for the firm, increased by 11% YoY to $64.6 billion, driven by 13.8% YoY growth in Search advertising and 13% YoY growth in YouTube ads (largely fueled by the retail sector). Google Cloud also showed robust performance with a 29% YoY revenue growth, slightly accelerating from previous quarters. The EBIT from this particular segment amounted to $1.2 billion. It's still the third-largest cloud provider in the world by market share (~11% of total), but its expansion is going quite strong actually even amid peers like Microsoft's (MSFT) Azure and Amazon's (AMZN) AWS, which is good: What also looked good in Q2 was the firm's cost control: the total cost of revenue rose by 8.6% YoY while EBIT surged by 25.6% to $27.4 billion, leading to the operating margin expansion to 32.4% (by 310 b.p.). Traffic acquisition costs rose by 7%, with the TAC margin narrowing by 80 basis points to 21%. The Other Bets segment, including ventures like Google Fiber and Waymo, reported a larger operating loss compared to the previous year, but their weight in Google's revenue structure was as always minimal. Alphabet's strategic focus on AI was highlighted during the recent earnings call for Q2, where the management noted that Google's AI initiatives are now being utilized by >2 million developers worldwide, while Gemini AI model is now integrated into various Google products, "enhancing user experiences and engagement." Indeed, Google is investing heavily in its technical infrastructure, with a reported $13 billion in CAPEX for Q2 alone (primarily for servers and data centers) and plans to maintain or exceed this level of investment throughout the year. I generally agree with the skeptics that this level of investment significantly impacts the company's chances of good ROIs, because it's not just Google making such substantial investments - this is the cost of competitive struggle. However, without these investments, the company will certainly be unable to compete on equal footing with Microsoft, Amazon, and other tech giants in the long term. Maintaining its competitive edge is indeed a challenging task. In my opinion, we can't simply conclude that Google is in a difficult period and that its capital investments may not be justified, leading us to avoid buying the stock. I believe the situation should be assessed differently, focusing on how the company's prospects will mathematically develop over the next few years, considering current uncertainties, risks, and opportunities. Therefore, I propose updating my DCF valuation model from the last quarter with new input data to see how the previous overvaluation I mentioned has changed. The market currently projects that the company's revenue will grow at a CAGR of ~8.3% over the next 5 years (i.e. until FY2028). I will adopt this consensus as my baseline assumption: Last time I built the model I projected that Google's EBIT margin would be between 35% and 36% in the coming years: Specifically, I projected it'd reach 36% in FY2027 and 37% in FY2028. This time, taking into account the antitrust trial risks, I'll assume that the company's margins will decline to 31% in FY2026. In FY2027, they will begin to gradually recover to 32%, and by FY2028, it'll reach 33%. This is below today's consensus, based on the free cash flow data I have. I'll also assume that the company's cost of debt is only 4%, meaning the bonds it issues today would trade at a relatively narrow spread to the risk-free rate, as they have historically. With the current risk-free rate of just 3.56% and a market risk premium (MRP) of 5%, I get a weighted average cost of capital of ~8.7%, which is 50 basis points lower than it was 3 months ago. Despite its dip over the past few weeks, Google stock is currently trading at a 29x EV/FCF multiple, while the average over the past 10 years is about 25.3x. I assume that by 2028, as the company's revenue growth rate declines, Google will trade at a 26-27x multiple - this reflects a natural erosion of valuation multiples, but share buybacks and the company's existing moat should theoretically support at least some premium to the historical norm. Given all the input data, I conclude that Google is approximately fairly valued today: However, when I look at the company's comparative valuation (through multiples), I find that today's P/E, when considering forward EPS, actually indicates an undervaluation of ~25%, suggesting a growth potential in today's valuation relative to the historical average (assuming the current consensus forecast for net profit is accurate). As far as technical analysis is concerned, this is how I see it. First, the recent price decline has taken Google to its 52-week moving average, a level not reached even during the decline earlier this year. This coincides with relatively weak historical seasonality, as Google has posted positive returns in September only 30% of the time over the past 11 years. However, this represents a potential buying opportunity for investors as seasonality improves immediately after September and the long-term weekly trend remains intact. Second, one of the worst-case scenarios for Google right now is the potential testing of the price gap that formed after the earnings report earlier in the year. However, I believe that as the price approaches this level, we'll see strong buying pressure that may serve as sufficient confirmation that the current correction is over. So based on all of the above, I decide to cautiously upgrade GOOG to "Buy" again, as I anticipate that most of the existing risks are already in the price. First of all, let me explain why I'm "cautiously" raising my rating. I'm genuinely concerned about investors who purchased Google a few weeks ago, before the recent dip, as there's a risk that the price may not return to those levels for many months. This is particularly true if the ongoing legal litigation continues and results in outcomes more significant than analysts currently anticipate. If Google is forced to sell some parts of its consolidated business, it'd be a very serious blow to its ability to generate value for shareholders, in my view. This is a significant risk that cannot be overlooked. Another risk to my current upgrade is the high level of competition. As you can understand, the intrinsic value of Google's stock today is tied to several key components. Google's growth story, its advancements in AI (the monetization of AI), can't be separated from its cloud business. In this area, Google faces competition from numerous technologically advanced peers. Additionally, while Google Search generates the largest share of the company's revenue and is largely a monopolist in its market, it still faces competition: Many people I know are already using ChatGPT to test hypotheses and solve minor problems instead of Google search engine, as it often provides more practical answers for them. If Microsoft and other competitors manage to outperform Google's innovative achievements and provide greater value to users, this could pose a significant challenge to Google's return on investments it expects to continue to increase. There's also a risk that I might misinterpret the current chart patterns. If we shift our focus from the weekly chart to the daily chart and change the 52-week moving average for a 200-day moving average, we'll see a concerning picture: The price closing below its long-term SMA could theoretically signal the end of the uptrend. Despite the obvious risks that keep putting significant pressure on Google today, I still believe that the likelihood of the company being forced to split up to comply with antitrust laws is greatly exaggerated. I generally agree with the analysis provided by JPM in their recent report, which focuses on negative impacts of only 3% to 7% to FY2026 EPS. So that's why I don't foresee a collapse or significant deterioration in the company's business. From what we observed in Q2 FY2024, things are progressing well. Yes, the company has more than doubled its CAPEX because of AI spending and continues to increase it, with substantial expenses planned. However, these investments should ultimately bear fruit, as failing to make them would certainly mean losing the innovation race. Even if we anticipate a drop in margins, as I did in my updated DCF financial model, the stock would turn out to be already fairly valued today, while based on valuation multiples, it may be even undervalued by about 25%. Therefore, I believe it's now reasonable to consider Google stock for a long-term or medium-term purchase; perhaps not full position at once, but gradually.

Alphabet Stock: This Compounder Just Became Undervalued (NASDAQ:GOOGL)

LLMs like ChatGPT didn't end up eating into Google's revenue as some people originally thought would happen, and AI Overviews can help Google stay competitive. Search engine giant Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG) is now down 21% from its all-time high. The stock has been falling due to the overall tech sector sell-off recently, with the Invesco QQQ Trust ETF (QQQ) down about 11% from its all-time high, and also because it is facing headwinds from antitrust lawsuits. However, I believe that it can navigate the antitrust issues, as it has in the past, although I recognize that it's a risk. There's also the question of how LLMs like ChatGPT and Perplexity can affect Google's ad revenues, but it seems like Alphabet has been handling the competition quite well. Overall, Alphabet remains a high-quality compounder with more growth ahead (especially from Google Cloud), and it's trading at a discount to its historical valuation multiples. When I see such a dominant growth company trading at a discount, I become bullish. Consequently, I rate GOOGL stock as a Buy. Alphabet is involved in some antitrust lawsuits right now, but I don't think it's anything worth worrying about, as this isn't the first time Alphabet has been involved in antitrust lawsuits. It has successfully navigated them in the past, as I'll explain below. But first, let's get into the current lawsuits. As a refresher, last month, judge Amit P. Mehta ruled that Google is guilty of illegally monopolizing the search market, violating antitrust law for over a decade to maintain its search engine dominance. On September 6, more news came out. The news is that by August of next year, the judge will share his decision on how to remedy Google's dominance. This can include "breaking up Google" and/or a "potential ban on the company paying phone makers to pre-install Google search," per The Washington Post. Also, recently, the Competition and Markets Authority found that is engaging in anti-competitive behavior in open-display ad tech. The short answer is yes. If Alphabet were to be forced to spin off its businesses, such as YouTube, Google Advertising, Google Search, Google Network, and potentially even Google Cloud, the total value of the separate entities could be higher than the current value of the combined entities, unlocking value for shareholders. Spinoffs are generally believed to create value for that reason, and this situation would be no different. In 2018, Google was fined €4.34 billion (about $5 billion) by the European Commission for abusing its dominance through the Android operating system. The press release from the European Commission stated, "Since 2011, Google has imposed illegal restrictions on Android device manufacturers and mobile network operators to cement its dominant position in general internet search." In 2017, Alphabet was hit with a €2.42 billion fine after it "abused its power by promoting its own shopping comparison service at the top of search results." The moral of the story here is that Alphabet ended up just fine, and those who feared the lawsuits missed out on big gains from the stock. Still, I will admit that the current lawsuits are larger in nature, as they directly target Google's Search business, so the risks are there. But again, there's also upside potential if spinoffs happen. Thus, what will happen remains to be seen, and it's something that I'll be monitoring but won't lose sleep over. Remember when everyone was afraid that ChatGPT and other LLMs would make Google obsolete? Well, that hasn't played out in the financials, and it might not happen at all. While it's true that some people (including myself) use Google less often these days in favor of a quick ChatGPT query, that doesn't mean Alphabet is done. Take the recent results, for example. In Q2 2024, revenue in the Google Search & Other segment increased to $48.509 billion from $42.628 billion in Q2 2023, a 13.8% increase, and total Google Services revenue (which includes the section I just mentioned) grew by 11.5% year-over-year to $73.928 billion. Total company-wide revenues grew by 13.6%. Alphabet wouldn't be growing by double-digits if LLMs were truly a problem. Additionally, Alphabet now has AI Overviews, which will keep people on the Google ecosystem. AI Overviews provide AI-generated responses to regular Google Searches using sources across the web. For now, the feature is only available in the U.S., but it will be made international eventually. In the most recent earnings call, Alphabet's CEO, Sundar Pichai mentioned the following about AI Overviews: "People who are looking for help with complex topics are engaging more and keep coming back for AI overviews. And we see even higher engagement from younger users, aged 18 to 24, when they use search with AI overviews. As we have said, we are continuing to prioritize approaches that send traffic to sites across the web. And we are seeing that ads appearing either above or below AI overviews, continue to provide valuable options for people to take action and connect with businesses." Based on the quote above and the financial results, it's clear that Alphabet continues to innovate to stay on top of its game, and ads will still show up with AI Overviews. For each quarter that passes, Google Cloud becomes a more relevant part of Alphabet's business. In Q2, 2023, the segment made up 10.8% of company-wide revenues and 1.8% of total operating income. In the most recent quarter, it made up 12.2% of revenues and 4.3% of operating income. Notably, Google Cloud's operating margin grew from 4.9% in Q3 2023 to 11.33% in the most recent quarter, and the segment's revenue grew by 28.8% to $10.347 billion. Also, Google Cloud's market share in the cloud infrastructure services market continues to grow, now at 10%, according to Canalys. In Q1 2022, it was 8%. Therefore, Google Cloud is not only outpacing the competition, but it's also rapidly improving its profitability in the process. Additionally, given that Amazon's (AMZN) AWS operating margin was over 35% for Q2, Google Cloud can see lots of margin expansion, even if it only reaches half of AWS's profitability. Overall, more growth is likely ahead for Google Cloud, especially with the cloud infrastructure services market expected to grow at a 17.3% CAGR from 2024-2033, according to Precedence Research. This, of course, should give GOOGL stock a long-term boost. Several metrics point to GOOGL stock being undervalued or at least reasonably priced at the moment. First, its P/E ratio comes in at 21.65x. This is notably lower than its five-year average of 26.7x. Second, its forward non-GAAP P/E (next 12 months) comes in at around 19x, compared to an average of 24.43x since October 2019. Third, its next-12-months price/FCF multiple is close to 22x, compared to an average of 23.75x since October 2019. Note that the screenshot below states 23.09x as the last figure, but that doesn't include today's 4% drop, which brings the multiple closer to 22x. Therefore, there's room for valuation multiple expansion with GOOGL stock (especially as interest rates eventually come down). However, even if you don't believe that to be true, there's still upside potential based on analyst estimates. For December 2025, analysts expect GOOGL's EPS to reach $8.69. That's about 1-and-a-half years out from now. If GOOGL achieves that and even sees a slight decline in its P/E ratio to 21x, that would give the stock a share price of $182.49, or about 20.9% higher than the current price of $150.92. That's not a head turner, but it's also not a bad return in 1-and-a-half years (it's roughly a 13.5% return annualized) for a more "base-case" scenario. Alphabet remains a high-quality, dominant large-cap stock with growth expected ahead. While there are risks associated with the antitrust cases, Alphabet has navigated these kinds of things in the past and has come out stronger. Also, a potential breaking up of the business can actually unlock value for shareholders via spinoffs. Looking past the lawsuits, Alphabet has been able to grow despite concerns about LLMs making Google Search obsolete, and its Google Cloud business is firing on all cylinders. Google Cloud is becoming more and more relevant (and profitable) each quarter, with lots more room for margin expansion if it can catch up to AWS's operating margins. Finally, when analyzing the valuation, GOOGL stock seems undervalued. Its current and forward P/E, as well as its forward FCF multiple, are below historical averages, and even if the firm sees a slight decrease in its P/E multiple, it can still return over 20% in about 18 months or so if it meets EPS estimates. Therefore, I rate GOOGL as a Buy.

Google: Quantifying SearchGPT Risks Vs Google Cloud Upside (NASDAQ:GOOG)

Looking for a portfolio of ideas like this one? Members of Best Of Breed Growth Stocks get exclusive access to our subscriber-only portfolios. Learn More " Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL) has struggled to enjoy the same AI boost seen at tech peers, in spite of posting resilient fundamental results. I suspect that Wall Street remains hesitant in light of emerging competition in search from the likes of both Microsoft (MSFT) and OpenAI. Wall Street's fears may be causing it to overlook the strong earnings power of the core businesses, as well as the upside potential from the fast-growing cloud unit. It may surprise some readers to learn that Google Cloud accounts for an insignificant amount of overall earnings, yet is arguably worth as much as 25% of the current market cap. I reiterate my strong buy rating for the stock. I last covered GOOGL in June, where I discussed how the stock can thrive in a generative AI world. The stock has underperformed the broader market by double-digits since. The stock offers an attractive setup which offers significant re-rating potential and high prospective annual returns while we wait. In the most recent quarter, GOOGL saw continued strength, with revenues growing 14% YoY - representing some sequential deceleration but a significant acceleration on a YoY basis - and earnings growing by 33% to $1.97 per share (I have adjusted for unrealized gains and losses on investment securities). Crucially, management has committed to cost discipline, as evidenced by the sequential decline in headcount and the 300 bps jump in operating margin. On the earnings call, management noted that headcount should rise sequentially in the third quarter due to the onboarding of new graduates. GOOGL saw around 13% revenue growth in both Google Search and YouTube. The company's results for YouTube apparently missed some consensus estimates, but I view this segment as being more of a long-term story than one that should be judged on a quarter-to-quarter basis. GOOGL saw Google Cloud revenues grow by 29%, representing a slight acceleration on a sequential basis. On the profitability front, Google Cloud notably breached $1 billion in operating income for the first time (I note that just 3 quarters ago that number stood at $266 million). This represents an 11% operating margin, but I continue to be of the view that margins should converge towards the 37% (and rising) margins seen at Amazon.com, Inc. (AMZN). GOOGL ended the quarter with $100.7 billion of cash and $34 billion of non-marketable securities versus $13.2 billion of debt, representing a $7 billion sequential decline in the net cash position. That was due to the company spending aggressively on returning cash to shareholders, as the $15.7 billion of share repurchases and $2.5 billion of dividends exceeded the $13.5 billion of free cash flow. On the call, management was optimistic about "increases in search usage, and increased user satisfaction with" their roll-out of AI overviews. It will be interesting to see how the search market develops given the recent entrance of OpenAI's competitive search product. Management, however, did caution that the third quarter will see the company lapping a tough comparables, as the second half of last year saw a recovery in spending from APAC-based retailers. Management also guided for quarterly CapEx to hover at around $12 billion, which would likely outpace depreciation & amortization costs and thus be a continued drag on free cash flow conversion. Regarding spending on the AI infrastructure, management stated that "the risk of under-investing is dramatically greater than the risk of over-investing," an eerily similar rhetoric to what is often said in past bubbles. That said, I note that this spending does not outpace depreciation & amortization expenses by so much and the company maintains a strong net cash balance sheet - thus failure to derive strong return on investment from these investments might not have such a catastrophic impact on the stock valuation. Notably, management committed to a "a new multi-year investment of $5 billion" for their self-driving segment, Waymo. Waymo has been making great progress on rolling out its services and continues to offer additional catalysts for upside beyond the core thesis. As of recent prices, GOOGL found itself trading at just around 20x fwd earnings. That in itself looks easily justifiable, and therein lies the investment thesis. Substantially all of the profits still come from the advertising businesses. Between the net cash position and the persistent secular growth, 20x earnings looks quite appropriate here. The cloud business has a $40 billion annual revenue run-rate and is growing at a 29% clip. I see 30x earnings as being a reasonable, if not still too conservative, multiple. Based on my projection of 40% long-term net margins, that equates to 12x sales, $480 billion in value, or $38 per share in excess value. The cloud segment alone implies 25% potential upside, and that is in addition to any upside from ongoing growth. If that valuation exercise felt too easy, there might be something to that. Perhaps investors might be skeptical that OpenAI search can take meaningful market share, or at the very least make enough of a dent in the growth story to make 20x earnings unjustifiable. In theory, that is a reasonable assumption given that GOOGL is still benefiting from various long-term tailwinds, including continued adoption of the internet (more users) and an increasing move towards digital advertising (more advertisers). The company may also be able to benefit from higher prices over time as well - there appears to be so many levers available to at least keep this in growth mode. The potential hiccup is if Apple's (AAPL) announced partnership with OpenAI eventually leads to the iPhone maker replacing Google with OpenAI (or someone else) as the default search engine. That said, the stock valuation can still look reasonable even assuming search revenues decline by 30% (roughly equivalent to iOS market share). Assuming 70% gross margins, a 30% decline in search revenues might lead to a 44% decline in net income. The stock would be trading at 35x earnings under such a scenario. That might imply around 42% potential downside (again assuming 20x earnings), but remember that Google Cloud can cushion around half of that number. That suggests that GOOGL stock might have around 20% potential downside under this worst-case scenario. Other risks include a faster than expected deceleration in top-line growth rates - perhaps consensus estimates prove too aggressive. Perhaps another competitor will emerge not just for search but also for YouTube. I also note that at 20x earnings, the stock may still have downside if the market overall were to face weakness. I find it more likely that GOOGL continues to show secular top-line growth alongside rapidly growing profitability as it benefits from the aforementioned secular tailwinds. It appears that the stock continues to trade at low valuations due to fears about disruption from OpenAI or others, but the market may be underestimating the potential upside from Google Cloud and others (like Waymo). While this is not the cleanest story, I still see a path to market-beating upside, especially given management's commitment to returning cash to shareholders. I reiterate my strong buy rating.