Many of the leading artificial intelligence companies are stuck between a rock and a hard place when it comes to pleasing investors. On one hand, the market has punished stocks of the leading hyperscalers when they’ve announced massive capital spending plans. At the same time, the hyperscalers don’t have much of a choice but to keep up with their peers in building out artificial intelligence compute capacity and spending heavily on its development. To forgo doing so would leave considerable amounts of money on the table, and the market would surely punish the stock.
The latter was seen in a recent development at Alphabet (GOOG 0.83%) (GOOGL 0.30%). The company recently lost two of the leading AI researchers to OpenAI and Anthropic. The market sent shares lower on fears that top talent is key to winning the AI race (even if paying that talent is detrimental to earnings).
Ultimately, long-term investors can win from temporary stock price displacements caused by the market’s capitulation over AI-related spending. And the recent sell-off in Alphabet shares looks like another great opportunity.
Image source: Getty Images.
Alphabet’s brain drain
Alphabet is losing John Jumper to Anthropic and Noam Shazeer to OpenAI. Jumper won the Nobel Prize for his work on AlphaFold, an AI system that predicts protein structures, accelerating key biological research. Shazeer has been an innovator in large language model development, authoring seminal papers on transformers (the “T” in GPT) and mixture-of-experts models, which improve the efficiency and effectiveness of AI inference.
Both researchers have made substantial contributions to Google’s AI development over the years and recently helped the Gemini family of models reach performance levels comparable to those of Anthropic and OpenAI models. To be sure, losing their talent and judgment in which projects to pursue will cause setbacks in Alphabet’s efforts to advance its AI capabilities.
However, investors may be overreacting to the loss of the AI researchers. The real value of Alphabet comes from extremely durable structural competitive advantages.
The massive opportunity the market is handing investors
Alphabet’s competitive advantage in artificial intelligence stems from its full-stack approach.
It’s one of the three largest public cloud computing platforms, giving developers access to foundation models, including its own, to build and deploy AI applications. To that end, Google Cloud is, by far, the fastest-growing of the group. Revenue climbed 63% year over year last quarter with operating margin expanding to 33% from 18% a year ago.
There are a few factors leading to that significant growth. First and foremost, Alphabet’s ability to spend on building more capacity. Capital expenditures have accelerated over the last few years, climbing even faster than Google Cloud’s revenue growth. That trend should continue, with management’s expectations for $180 billion to $190 billion in capital spending this year and a recent $80 billion equity raise. Still, investors have seen strong returns from that spending in the form of Google Cloud revenue.
Additionally, Alphabet has seen strong adoption of its custom TPU chips, which offer better price performance than standard GPUs for AI training and inference. That’s enabled it to achieve higher operating margins and maintain better control over supply.
Today’s Change
(-0.83%) $-2.85
Current Price
$342.19
Market Cap
$4.2T
Day’s Range
$335.90 – $343.19
52wk Range
$170.86 – $404.47
Volume
27.7M
Avg Vol
20.7M
Gross Margin
60.43%
Dividend Yield
0.25%
The second structural advantage for Alphabet is its ability to deploy artificial intelligence to improve its core advertising business. Search ad revenue has accelerated over the last year and a half, climbing 19% year over year in the most recent quarter. That growth coincides with the broader deployment of AI-powered features like Google’s AI Overviews and AI Mode. Management says its ad targeting has improved as its models can better understand search intent, thanks to advancements in Gemini.
To be sure, Alphabet needs excellent talent to continue advancing its AI models. But its ability to deploy those models to produce strong returns across its business is currently unmatched. It should be able to replenish the talent pipeline to continue feeding its opportunities across cloud computing and consumer applications.
But with the sell-off in shares following the news of Jumper’s and Shazeer’s departures, the stock now trades for less than 25 times earnings expectations. That’s incredibly inexpensive for a company growing revenue by more than 20% and accelerating, while producing operating margin expansion on top of that. As such, it looks like a great opportunity for long-term investors.