Google's Strong Position in AI and Growth Potential Amidst Tech Giants' Competition

Google Q2: Almost The Cheapest Magnificent 7 Stock, Double-Digit Growth Expected (GOOG)

Combined with its market-leading streaming share and monetization of autonomous driving through Waymo, it is apparent that the market is sleeping on GOOG's well-diversified capabilities. We previously covered Alphabet Inc. aka Google (NASDAQ:GOOG) in May 2024, discussing its promising prospects in the search engine/ generative AI capabilities, along with robust profitability and rich balance sheet in FQ1'24. Combined with its ability to consistently deliver profitable growth and robust shareholder returns, we had upgraded our Buy rating to Strong Buy then, with the stock still fairly valued while offering an excellent upside potential. Since then, GOOG has further rallied by +16.1%, well outperforming the wider market at +8.4%, before the recent rotation away from high growth stock over the past two weeks. Even so, we are maintaining our optimism surrounding its long-term prospects, thanks to its double beat FQ2'24 earnings call and accelerating Cloud performance metrics. Combined with relatively cheap P/E valuations compared to its Magnificent 7/streaming/autonomous driving peers, it goes without saying that the stock remains a long-term winner for growth oriented investors. GOOG has had a volatile three years indeed, as observed in the stock price chart above, attributed to the pre-pandemic boom, subsequent correction after November 2021, and the eventual recovery after the January 2023 bottom. Despite the previous market concerns about the longevity about its Google Search segment, as discussed in our GOOG article here in January 2023, it is apparent that those fears have been unfounded. At the same time, GOOG is also nearing its projected $100B revenue run-rate from both YouTube Ads and Google Cloud by end 2024, as observed from the cumulative FQ2'24 revenue of $19B (+7.5% QoQ/ +21% YoY/ +233.5% from FQ2'19 levels of $5.7B). Most importantly, the management has demonstrated their ability to push Google Cloud into sustained profitability, despite our original skepticism surrounding the new accounting methodology, attributed to the extended "useful life of its servers from four to six years and network equipment from five to six years." This has led to Google Cloud's expanding operating margins of 11.3% in FQ2'24 (+1.9 points QoQ/ +6.4 YoY), further underscoring why their ongoing innovation across every layer of the AI stack has paid off handsomely. This is also why we believe that as an AI-first company, GOOG has demonstrated robust monetization efforts across its search/ generative AI/ cloud offerings, thanks to its multi-modal integrated AI capabilities, which in turn enhances the user experience and increases search engine loyalty. We must remind readers that GOOG boasts an in-house AI team compared to Microsoft's partnership with OpenAI, which enables the former to vertically integrate the platform building expertise while innovating across its existing/ new offerings. This further underscores why the management has been able to rapidly deploy/ monetize Gemini across its developer tools and data center to edge use cases. Combined with the sustained rationalization of its offerings and headcounts, it is unsurprising that we have seen GOOG's robust top-line growth flow into its increasingly richer adj operating margins of 32.3% (+0.7 points QoQ/ +3.1 YoY/ +8.8 from FQ2'19 levels of 23.5%) in FQ2'24. With consensus forward estimates remaining stable over the past three months and GOOG still expected to report an accelerated top/ bottom-line expansion at a CAGR of +11.6%/ +19.4% through FY2026, it is apparent that the stock remains cheap here. This is especially since GOOG at FWD P/E valuations of 21.29x is still trading well below its Magnificent 7 peers (aside from META at 22.06x) and its 5Y P/E mean of 25x, as observed in the chart above. Even compared to their bottom-line growth rates, such as Meta at 22.06x at +20.9% through FY2026, AAPL at 31.46x/ +10.3%, MSFT at 33.88x/ +16.5%, AMZN at 37.91x/ +37.5%, NVDA at 38.93x/ +49.6%, and TSLA at 72.15x/ +13.3%, respectively, it is apparent that GOOG is on the cheap side compared to the other Mag 7 peers. Given YouTube's leading streaming share of 8.4% in June 2024 (+0.8 points MoM/ +0.2 YoY) in a growing overall market of 40.3% (+1.5 points MoM/ +2.6 YoY), it is apparent that the secular transition from TV Media to streaming is still ongoing. Even when compared to its streaming peer, Netflix (NFLX) at FWD P/E valuations of 33.57x with the projected adj EPS growth at +31.1% through FY2026, it is apparent that GOOG remains highly attractive at current levels. Lastly, readers must not forget GOOG's autonomous driving capability, Waymo, which has started to deliver over 50K weekly paid public rides in San Francisco and Phoenix, along with its ongoing fully autonomous testing (without driver). While TSLA has touted robo-taxi capabilities with an event now planned in October 10, 2024, it remains to be seen when monetization may actually occur, with Waymo currently leading the race. As a result of these developments, we maintain our belief that the market is sleeping on GOOG's well-diversified capabilities, with it offering interested investors with an excellent margin of safety despite the massive rally since the January 2023 bottom. For now, GOOG has charted a new peak of $190s and is trading above its 100/ 200 day moving averages, thanks to the robust FQ2'24 earnings results and the market's conviction surrounding its AI monetization. Despite the recent correction, the stock continues to trade not too far from our previous article levels of $170s, with current levels still near to our updated fair value estimates of $174.20, based on the LTM adj EPS of $6.97 (+6.9% from the previous levels of $6.52) and the 5Y P/E valuations of 25x. At the same time, there remains an excellent upside potential of +40.6% to our reiterated long-term price target of $258.30, based on the flattish consensus FY2026 adj EPS estimates. In addition, GOOG has executed well on its long-term shareholder returns, based on the 269M shares, or the equivalent 2.1% of its float retired over the LTM, and 1.35B/ 9.7% since FY2019, with approximately $54B still remaining in its repurchase authorization. While minimal, the annualized $0.80 dividend per share allows long-term shareholders to DRIP and accumulate additional shares on a quarterly basis. As a result of its robust AI monetization prospects and dual pronged prospective returns through capital appreciation/ dividend payouts, we are maintaining our Buy rating for the GOOG stock here.

Google Continues Performing Well As The World Embraces AI (GOOG)

Per my May article, Alphabet/Google's (NASDAQ:GOOG) (NASDAQ:GOOGL) key segments are doing well. The 2Q24 numbers have come out since that time, and we see continued improvement across the board. My thesis is that Google continues performing well as the world embraces AI. The 2Q24 operating income figures are better than ever and the 2Q24 revenue numbers are impressive as they almost matched the seasonal figures from 4Q23: Is 9.11 bigger than 9.9? This is a question which has been breaking the internet because LLMs like ChatGPT and Meta AI (META) often get the answer wrong. When we use Google's search bar to ask this type of question with 3.11 and 3.9, their Gemini LLM gives us the correct answer before we see search engine result pages ("SERPs") which also have the correct answer: I am sanguine about Google continuing to make money from traditional SERPs while also including helpful AI snippets when people make searches on the internet. Per Nielsen's The Gauge, YouTube and Netflix dominate the US streaming market. It is mind-boggling when we think about the fact that the combination of tech companies like YouTube, Netflix, and Amazon Prime is responsible for more streaming hours in the US than all the traditional Hollywood companies combined. I believe the tech companies will continue to lead as they find creative ways to use generative AI that resonate with younger viewers: Google Cloud has grown quickly such that their quarterly revenue is now over $10 billion ($ in millions): The early days for AWS (AMZN) were easier than what we see today for Google Cloud because competition was lighter and massive AI investments were not required ($ in millions): I believe Google Cloud, AWS, and Microsoft Azure will continue to do well as these 3 hyperscalers are the only companies with the resources to make heavy AI investments in the years ahead. Platformonomics shows that even iconic database companies like Oracle (ORCL) can't keep up with the big 3 hyperscalers: Well, obviously the real reason that they canceled it is because GM can't make it work, not because of the regulators, they're blaming regulators. That's misleading of them to do so, because Waymo is doing just fine in those markets. So it's just that their technology is not far. An October 2023 blog post explains Waymo's history with AI: For over a decade, Waymo has been addressing complex AI and ML challenges in autonomous driving, robotics and computer vision. The above blog post also says rides will be offered to the public in Austin by the end of 2024. Waymo opened themselves up to the public in San Francisco in June 2024. Summing things up, Waymo has been using AI for a decade and they are already available to the public in Phoenix and San Francisco. They will also be available to the public in parts of Los Angeles and Austin by the end of 2024. This was discussed in the 2Q24 call: Waymo's served more than 2 million trips to-date and driven more than 20 million fully autonomous miles on public roads. Waymo's now delivering well over 50,000 weekly paid public rides, primarily in San Francisco and Phoenix. And in June, we removed the waitlist in San Francisco, so anyone can take a ride. Fully autonomous testing is underway in other Bay Area locations without a human in the driver's seat. A January post by former Tesla AI Director Andrej Karpathy talks about the potential for Waymo and Tesla. He implies it is now a question of when and a question of who with respect to robotaxis as opposed to a question of if. He highlights the different strategies used by Waymo and Tesla: At some point, these [AI] systems cross the threshold of reliability and become what looks like Waymo today. They creep into the realm of full autonomy. In San Francisco today, you can open up an app and call a Waymo instead of an Uber. A driverless car will pull up and take you, a paying customer, to your destination. This is amazing. You need not know how to drive, you need not pay attention, you can lean back and take a nap, while the system transports you from A to B. Like many others I've talked to, I personally prefer to take a Waymo over Uber and I've switched to it almost exclusively for within-city transportation. You get a lot more low-variance, reproducible experience, the driving is smooth, you can play music, and you can chat with friends without spending mental resources thinking about what the driver is thinking [while] listening to you. Additional investments in Waymo were discussed in the 2Q24 call. I'm optimistic that these investments will work out well as Waymo races against Tesla to get the robotaxi business to scale: With regard to other bets, we continue to focus on improving overall efficiencies, as we invest for long-term returns. Waymo is an important example of this, with its technical leadership coupled with progress on operational performance. As you will see in the 10-Q, we have chosen to commit to a new multi-year investment of $5 billion. This new round of funding, which is consistent with recent annual investment levels will enable Waymo to continue to build the world's leading autonomous driving technology company. The CFO and CEO can have a big impact on valuation, and the 2Q24 call was the last one for Ruth Porat in the CFO position. Forward-looking investors need to keep tabs on her replacement, Anat Ashkenazi. Adjusted FCF looked pretty good relative to operating income up through 3Q23, but it has been very low since then: *I treat share-based compensation ("SBC") like a cash expense above, so I subtract it and capex from operating cash flow when coming up with the adjusted FCF figures. Also, the adjusted operating income above is higher than the GAAP numbers in 2Q17, 2Q18, and 1Q19 because fines of $2,736 billion, $5,071 billion, and $1,697 billion, respectively, are excluded. Again, the adjusted FCF above was low starting in 4Q23 due to heavy capex and this was discussed in the 2Q24 call when Barclays (BCS) Analyst Ross Sandler asked about the AI capex cycle: So it looks like from the outside at least, the hyperscaler industry is going from kind of an under-bill situation this time last year to better meeting the demand with capacity right now to potentially being overbuilt next year if these CapEx growth rates keep up. So do you think that's a fair characterization? And how are we thinking about the return on invested capital with this AI CapEx cycle. CEO Sundar Pichai responded by saying we are at an early stage of a transformative area in tech. With respect to transitions, he likes the idea of aggressively investing upfront in a defining category (emphasis added): I think the one way I think about it is when we go through a curve like this, the risk of under-investing is dramatically greater than the risk of over-investing for us here, even in scenarios where if it turns out that we are over investing. We clearly - these are infrastructure, which are widely useful for us. They have long useful lives and we can apply it across, and we can work through that. But I think not investing to be at the frontier, I think definitely has much more significant downside. Having said that, we obsess around every dollar we put in. Our teams are - work super hard, I'm proud of the efficiency work, be it optimization of hardware, software, model deployment across our fleet. All of that is something we spend a lot of time on, and that's how we think about it. Forward-looking investors need to keep tabs on the difference between accrual profits and adjusted FCF, especially as the new CFO makes investment decisions and communicates the thought process in quarterly calls. Citing a July Needham note, Bloomberg says YouTube could be worth at least $455 billion, and it is one of many parts in the Google Services segment whose largest contributor is the search business. Trailing twelve months ("TTM") operating income for the Google Services segment is $109,502 million or $52,897 million + $95,858 million - $39,253 million. This comes from TTM revenue of $293,433 million or $165,281 million + $272,543 million - $144,391 million. I believe this segment is worth 18 to 20x operating income for a range of $1,970 to $2,190 billion when rounding to the nearest $5 billion. Google Cloud might not ever have the same operating margin as AWS, but I think they can improve from today's level of 11% to at least 15% as the business scales. Based on the $10,347 million in revenue for 2Q24, the revenue run rate is $41.4 billion. The operating margin may not be 15% for a few more years, but I'm optimistic it will get there eventually and if we use that percentage now, then it implies a hypothetical operating income level of $6.2 billion based on the revenue run rate. Applying a multiple of 18 to 20x gives us a valuation range of $110 to $125 billion when rounding to the nearest $5 billion. Looking at the 2Q24 10-Q, we are given share counts as of July 16th. We add the 5,859 million A shares and the 866 million B shares and multiply this sub-total of 6,725 million shares times the July 25 GOOGL share price of $167.28 to get the first component of the market cap, which is $1,125 billion. We add this to the second market cap component which is $945 billion based on the 5,585 million C shares times the July 25 GOOG share price of $169.16. This gives us a market cap of $2,070 billion. The stock is near the low end of my valuation range, and I think it is a buy for long-term investors who are planning to hold it for at least 3 years.

Meta Platforms: Still A Compelling Opportunity As Earnings Near (META)

Looking for a helping hand in the market? Members of Crude Value Insights get exclusive ideas and guidance to navigate any climate. Learn More " With a market capitalization as of this writing of $1.24 trillion, Facebook parent Meta Platforms (NASDAQ:META) is one of the largest publicly traded companies on the planet. It wasn't so long ago, however, that the company was considerably smaller than this. Back in October of 2022, I ended up rating the company a 'strong buy' after the stock had plummeted materially. There were concerns about the business hemorrhaging cash because of its investments in augmented reality. But I ultimately concluded that the picture for shareholders was very favorable. From that time through the present day, the stock is up an unbelievable 398.6% at a time when the S&P 500 is up only 43.1%. But as is common amongst value investors, I ended up selling my own shares far too early, coming in just shy of doubling the money I put into the business. It was around that time that I downgraded the stock. But even as of my most recent article, published in early May of this year, I had the company rated a 'buy'. And during that time even, shares have continued to outperform the broader market, having risen by 11.5% at a time when the S&P 500 is up by 10%. The fact of the matter is that these are fascinating times for the business. Although management continues to generate billions of dollars annually into Reality Labs with little to show for it, the core business is growing at a nice clip. But of course, investors would be wise to pay attention to new data as it comes out. After all, the picture can always change at a moment's notice. It just so happens that, after the market closes on July 31st, management is going to be announcing financial results covering the second quarter of the company's 2024 fiscal year. And the positive thing about this is that there is currently the expectation of continued year-over-year growth. So long as nothing negative comes out of the woodwork, I think that this will justify the 'buy' rating that I have kept the stock at as of late. And it will help shares continue to outperform the broader market for the foreseeable future. The first thing that the market will be paying attention to when management does report results on July 31st will be revenue and earnings. At present, analysts anticipate sales of $38.28 billion. If this comes to fruition, it would represent an increase of 19.6% over the $32 billion the company generated the same time last year. Better monetization of the platform, combined with continued growth in the number of active users on it, will be responsible for any sort of revenue increase. It is worth noting that the estimates provided by analysts are near the higher end of the range that management forecasted. They currently think that sales will come in at between $36.5 billion and $39 billion. At the midpoint, this would be $37.75 billion for a gain of 18% year over year. In all likelihood, the bottom line for the company will also come in strong. Analysts are forecasting earnings per share of $4.74. This would be well above the $2.98 per share reported the same time last year. Assuming no change in share count, this would mean a rise in net income from $7.79 billion last year to a whopping $12.44 billion this year. Unfortunately, management has not provided any estimates here. But given the company's track record, I wouldn't be surprised if earnings come in at or above forecasts. There are, of course, other profitability metrics that investors should be paying attention to. First and foremost, we have operating cash flow. No estimates have been provided for this or for the other profitability metrics. But for the second quarter of 2023, this metric totaled $12.06 billion. If we adjust for changes in working capital, however, we do get a considerably lower reading of $6.18 billion. Another metric that will matter will be EBITDA. For context, this time last year, the metric came in at $12.80 billion. Fundamentally speaking, Meta Platforms has been doing really well as of late. In addition to seeing growth in revenue over the past couple of years now, the company has also been able to significantly boost its profit margins. This has been a key driver behind value creation for investors. Over the past year or so, management has been dedicated to cutting certain costs. But this doesn't mean that we will see a linear progression. In fact, in its second quarter earnings release, the company increased guidance for total expenses for this year to be between $96 billion and $99 billion. The upper end of that range was unchanged from when the company announced results for the end of 2023. But the lower end of the range was up $2 billion from the $94 billion previously anticipated. Regardless of what happens for this year as a whole, there is no denying that growth and cost-cutting initiatives have been instrumental in pushing the stock higher. Even though margins are, for the most part, lower than they were in 2021, they are up a lot from what they were in 2022. From 2022 to 2023, the company's net profit margin shot up from 19.90% to 28.98%. It's adjusted operating cash flow margin grew from 38.41% to 49.87%. And its EBITDA margin went from 36.22% to 42.94%. All of this can be seen in the chart above. And in the chart below, you can see continued improvement for the first quarter of 2024 compared to the first quarter of last year. If the company is to outperform on the bottom line, margin expansion will be necessary. In fact, if we take analysts estimates for the second quarter of the year, this implies a net profit margin of 32.51%. For the same time of 2023, the net profit margin was only 24.34%. What I find to be really interesting is that these margins have improved even at a time when the company continues to invest heavily in Reality Labs. Even as revenue dropped from $2.27 billion in 2021 to just under $1.90 billion last year, the operating loss of that segment exploded from $10.19 billion to $16.12 billion. Admittedly, there was a slight improvement in the first quarter of this year, with a loss of $3.85 billion compared to the $3.99 billion reported one year earlier. But this came on the back of a slight improvement in revenue from $339 million to $440 million. Management has not offered much at all in the way of guidance on some of this stuff. But they did caution investors, in the first quarter earnings release of this year, to expect the company to 'invest aggressively' in support of its AI research and product development activities. So I wouldn't be surprised to see continued significant losses on this front. Less certain will be the overall cash position of the business. After seeing net cash plummet from about $48 billion in 2021 to $30.82 billion one year later, we saw a growth to $47.2 billion in 2023. But by the end of the first quarter of this year, net cash had fallen some to $39.74 billion. This seems to be the result of a couple of things. For starters, the company did finally start paying a dividend. And in the first quarter of 2024, it allocated $1.27 billion toward these distributions. But more importantly, management has also ratcheted up share buybacks. In the first quarter of this year alone, the company allocated $15.01 billion toward the repurchase of common stock. This was up from $9.37 billion one year earlier. This does mark a rather significant turnaround from prior years. From 2021 through 2023, annual share buybacks dropped from $44.54 billion to $19.77 billion. I would have liked for more purchases to occur when the stock was far cheaper. But the picture is what it is. As for valuation, guidance will ultimately determine what the picture looks like. But using the same numbers as in my prior article and updating for the increase in price that shares experienced, you can see in the chart above how shares are valued on a forward basis for 2024 and using historical results for 2023. Considering the high quality operation that we are talking about, and the historical growth the company has exhibited, I wouldn't say that the stock is overvalued. But it's not cheap enough to get me to pull the trigger. As earnings near, investors are probably getting anxious. The stock has risen significantly and, at some point, further market beating upside will be impossible. But I don't think we are there just yet. Even though the stock has gotten a bit pricey for my liking, I do think that this is a high quality company that's worthy of a 'buy' rating at this point in time.