Investment Review №328. Waiting for change

Alphabet (GOOGL) shares surged over 9% to an all-time high above $235, adding $234 billion in market capitalization, as investors welcomed a key regulatory victory. The ruling allowed the company to retain Chrome and Android within its ecosystem, as well as its lucrative search partnership with Apple.

The market’s positive reaction is understandable. However, among the Magnificent Seven, Alphabet has long been considered one of the more conservatively valued stocks, trading at a forward P/E multiple of around 23x. Regulatory headwinds and escalating rivalry from AI-powered platforms challenging Google’s core search dominance have continued to weigh on the company’s valuation. Even strong financial results have failed to reverse this trend: in Q2, total revenue grew 14% y/y to over $96 billion, while net income rose 19% to more than $28 billion—surpassing analyst expectations by over 2% and 5%, respectively. Alphabet’s cloud segment remained a strong competitor to Amazon (AMZN) and Microsoft (MSFT), while YouTube’s ad revenue approached $10 billion, nearly matching Netflix’s (NFLX) revenue of just over $11 billion. Ultimately, the company remains a cash-generating powerhouse, but competitive headwinds from AI providers are visibly chipping away at its core market share. Google’s dominance in search dipped below 90% for the first time since 2015, with ChatGPT now capturing roughly 9% of digital queries despite its relatively recent launch. Among Gen Z users, 66% now rely on ChatGPT for information searches compared to 69% who use Google—signaling a potential generational shift in search behavior.

With regulatory risks significantly diminished, Alphabet may finally break out of its long-standing undervaluation, supported by two strategic moves made over the past 15 years. First, modern AI solutions originated from DeepMind Technologies, which Google acquired in 2014. While Gemini—Google’s unified generative model—currently lags behind OpenAI’s flagship model, ChatGPT, in both scale and performance, the gap is unlikely to remain wide, given Google’s strong research foundation. Future success will largely depend on market positioning—and on that front, the outlook appears favorable. For instance, integrating AI capabilities into every Android smartphone— nearly 4 billion devices globally— offers a major advantage over ChatGPT, which lacks a native hardware ecosystem. Second, since 2013, Alphabet has been developing custom TPU chips that offer both cost and performance benefits for machine learning workloads. This gives the company a technical edge while reducing its dependence on Nvidia (NVDA), creating a vertically integrated device-to-OS ecosystem akin to Apple’s (AAPL) model. The revised 2025 capital expenditure forecast—raised from $75 billion to $85 billion—underscores Alphabet’s confidence in rising AI infrastructure demand and its readiness to scale investment to secure greater market share.

For investors, the company offers a rare blend of defensive qualities and growth potential. Its commanding 87% share of the search market provides recession-resilient cash flow, while leadership in AI and cloud expansion fuels growth that outpaces the broader market. Supported by reasonable valuation multiples and a rock-solid balance sheet, Alphabet presents compelling upside and a strong risk-return profile—making it an ideal anchor for portfolios seeking returns above the market average.