Nvidia (NASDAQ: NVDA) has almost single-handedly taken the stock market to new highs this year. Well, that may be an exaggeration, but it sure does feel like it. Investors have clamored to own shares of Nvidia after realizing just how essential the semiconductor supplier is to the infrastructure and growth for artificial intelligence (AI) solutions. The company offers premier computing solutions for AI and has enjoyed incredible pricing power with its customers.
But what if I told you another technology giant not only has its own Nvidia-like subsidiary, but it's also the only company with the assets to vertically integrate the entire AI supply chain?
Enter Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL).
That's right, the owner of Google Search has the hardware, infrastructure, software, and engineering talent built up over a decade that nobody can match in AI tech today. What's more, the stock actually trades at a reasonable earnings multiple after falling 20% from its all-time high in the past several weeks.
Here's why you should buy Alphabet stock if you missed out on Nvidia's monster gains.
Alphabet: The only vertically-integrated player in AI
Nvidia has made the graphics processing unit (GPU) a must-have component in the buildout of AI systems, but GPUs have been around far longer than AI has been in the headlines. Inspired by these computer chips, Alphabet began investing in its own computer chip design 10 years ago. It came out with the first tensor processing unit (TPU) in 2015. The goal of TPUs is to optimize Alphabet's massive computing costs stemming from its Google Search, YouTube, and other consumer internet properties.
This computing hardware has now advanced rapidly. The sixth generation Trillium that launched this year has a 4.7x increase in compute performance versus the prior TPU generation. That is a lot of cost savings that Alphabet will be able to implement across all its new AI products.
TPUs are like Alphabet's in-house Nvidia operation, the backbone of its AI computing. However, it goes much further than just optimizing chip performance. Alphabet has the Google Cloud unit -- powered by TPUs, of course -- that sells Alphabet's AI capabilities to third parties. Google Cloud hit $10.3 billion in revenue last quarter and is growing 29% year over year. There is a long runway for this division as demand for AI grows.
Of course, Alphabet has a data advantage for training AI tools as well. Google Search, YouTube, and other Alphabet properties have billions of users around the world that can be used to train AI models. Alphabet's dataset here is proprietary, which is why OpenAI (the organization behind ChatGPT) may encounter legal trouble from scraping data from YouTube transcripts to train its own AI.
Lastly, Alphabet has the best AI talent in the world and has been investing in AI researchers since acquiring the DeepMind research lab in 2014. Some competitors may be able to match Alphabet's capabilities on one part of the AI supply chain, such as Amazon with its cloud-computing operation. However, there is no company with the combination of computing tech, cloud infrastructure, data troves, and human talent that can match Alphabet in AI. This is why Alphabet has a head start to win in AI this decade.
Lots of growth but at what cost?
There is clearly growth in demand for AI research and computing capacity. But how will that show up on Alphabet's bottom line and generate more profits for the company? In a conference call this year, Alphabet CEO Sundar Pichai said that there was a bigger risk of underinvesting in AI than potentially overinvesting and wasting money. Shareholders hate wasting money, though, which is perhaps why the market has been bearish on Alphabet stock recently.
Management is planning on spending tens of billions of dollars on capital investments for new AI capabilities across its various internet properties. In order to get a proper return on this invested capital (ROIC), it will need to keep growing revenue across its three main segments: Google Search, YouTube, and Google Cloud.
Last quarter, Google Search (which also includes other Google properties) grew revenue 14% to $48.5 billion. YouTube advertising grew 13% to $8.7 billion. Google Cloud, we talked about above. So far, so good for Alphabet in the age of AI. However, investors will need to keep a close eye on revenue growth. If Alphabet spends all this money on AI infrastructure and revenue growth slows, profits will likely fall. That's just how the income statement math works.
The stock looks like a bargain
After the stock's recent drawdown, Alphabet now trades at a price-to-earnings ratio (P/E) of just 23. That is much lower than other tech industry competitors, such as Apple, which has a P/E of 33 while growing more slowly. The broader S&P 500 index trades at a P/E close to 29.
If you are a believer in Alphabet's AI advantage, the stock looks like a bargain right now. Revenue growth across its cloud, YouTube, and Google Search segments should translate into strong earnings. Meanwhile, management keeps repurchasing stock and just announced a new dividend, which will boost returns for shareholders.
There's a lot to like about Alphabet stock at current levels. If I wanted to bet on the growth of AI, this is the stock I would buy right now.
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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Brett Schafer has positions in Alphabet and Amazon. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, and Nvidia. The Motley Fool has a disclosure policy.
Missed Out on Nvidia's Monster Gains? Buy This AI Stock Instead was originally published by The Motley Fool