Alphabet | Fundamental Analysis

After a strong rebound in 2023, the tech sector has maintained its momentum through the first half of this year. Prominent tech-heavy indexes such as the Nasdaq Composite and Nasdaq-100 have increased by approximately 20% and 19%, respectively, driven largely by the growth of major tech stocks.

Alphabet, like many stocks associated with artificial intelligence (AI), has reaped the benefits of the technology's mainstream adoption. This year, Alphabet's stock has surged nearly 32%, reaching a new all-time high in late June.

When stocks approach their peaks, many investors become cautious, fearing a potential correction. Whether this will happen remains uncertain, but long-term investors are doubling down on Alphabet for several reasons.

Alphabet's primary revenue source continues to be Google advertising. In the first quarter, Alphabet generated $80.5 billion, with over 76% coming from Google advertising. However, this percentage is lower than in previous quarters, indicating a decreasing reliance on this revenue stream.

Concerns about the impact of new AI implementations on Alphabet's advertising revenue are understandable but likely overstated. On one hand, Google earns revenue when users click on search ads, and if users find answers through Google's AI Overview, a slowdown might occur.

Conversely, AI integration creates new advertising opportunities with innovative ad formats. Given the importance of Google advertising to Alphabet's business, the company is unlikely to overlook the effects of its AI Overview implementation.

With around a 90% market share in online search, Alphabet has significant leeway to experiment and find ways to boost user engagement and develop more targeted advertising opportunities.

The cloud computing industry is experiencing rapid growth, with AI advancements expected to further accelerate this momentum. Google Cloud, although trailing behind Amazon Web Services (31% market share) and Microsoft Azure (25% market share), has recently achieved profitability and is poised to improve overall margins.

Cloud platforms incur significant fixed costs, including data center operations and other infrastructure-related expenses. Achieving sustainable profitability requires reaching a certain scale, and Google Cloud appears to have reached this point. This shift is expected to enhance financial performance from a segment that previously pressured margins.

In the first quarter, Google Cloud generated $9.6 billion in revenue, an increase of $2.1 billion from the previous year. Operating income saw an even more substantial rise, jumping over 370% year-over-year. This increased efficiency boosted Alphabet's operating margin to 32%, up from 25% last year.

The "Magnificent Seven," a term referring to seven of the world's most influential tech companies - Microsoft, Apple, Nvidia, Amazon, Meta Platforms, Tesla, and Alphabet - significantly impact the tech sector's performance.

Alphabet appears to be the most "affordable" among these giants, with a price-to-earnings (P/E) ratio just under 28. While being the cheapest in the Magnificent Seven does not necessarily mean Alphabet is inexpensive, it is more attractively priced compared to its average over the past decade. This presents a potential opportunity for investors to acquire shares in a top-tier company at a reasonable valuation. Alphabet's robust growth prospects justify its valuation for long-term investors.

The growth may not be immediate, but Alphabet's newly announced dividend could help maintain investor patience. The quarterly dividend is $0.20, with a yield below 0.5%, making it less appealing for income-focused investors. However, the initiation of a dividend program signals Alphabet's confidence in its financial health and its ability to sustain long-term profitability.