Tech
Google: The Cheapest Stock in the “Magnificent 7” (NASDAQ:GOOG)
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Investment Thesis
Alphabet Inc.'s (NASDAQ:GOOG, NASDAQ:GOOGL) GenAI roadmap since the beginning of the year has driven a strong rise in the company's stock price. From Gemini 1.5 to AI Overviews, the company is integrating GenAI capabilities into all of its products and services. I believe GOOGL's valuation will depend heavily on the success of its AI monetization strategy, which has already shown early success in its last earnings report.
In our previous analysis, we upgraded the stock to Buy from Hold in July 2023 as the company saw signs of a recovery in online advertising. Since then, the company has seen strong growth in Google search and YouTube advertising revenues, driving the stock price up 40%, outperforming the S&P 500 index's 20% gain. The recent rally did not come without a significant increase in the P/E ratio, driven by an average 54% year-over-year EPS increase over the past three quarters, suggesting that valuation could rise further. We therefore reiterate our bullish view on the stock, with capital expenditures expected to increase 50% year-over-year in FY24 to sustain top-line growth and margin expansion in the long term.
Accelerating AI monetization
Last year, Google Search integrated GenAI to help users efficiently navigate to the content they want. Now, the company is adding new Gemini models to make Google Search more intelligent. In addition, Google Search users in the U.S. can get instant answers with AI Overviews, introduced in May. Management expects to reach more than 1 billion users by the end of 2024.
The company's Q1FY24 revenue results beat all market consensus. The continued acceleration in growth of Google Search revenue, which accounted for 57.3% of total revenue last quarter, was encouraging. I believe GenAI monetization in Google Search has materialized as segment revenue growth improved significantly from 1.9% YoY in Q1FY23 to 14.4% YoY in Q1FY24, and the company's total revenue grew 15.4% YoY. This indicates that the pace of GenAI monetization is faster than market expectations.
Short videos are key to YouTube advertising growth
Now, let's look at another positive sign: the YouTube advertising segment showed a strong recovery in growth, driven by both direct response and brand advertising, crossing the 20% year-over-year threshold for the first time since Q4 FY21. GOOGL is beginning to focus more on monetization as it approaches the second anniversary of the launch of advertising on YouTube Shorts.
According to Statista, YouTube Shorts users are expected to grow at a compound annual growth rate of 4.7% from 2023 to 2027. While this growth rate is not large, the company is working on a monetization strategy to improve ad revenue growth. During the earnings call, management discussed how YouTube Shorts monetization will continue to improve as AI drives improved ROI. Like most of TikTok's AI features, YouTube Shorts previously introduced Dream Screen, which allows users to create AI-generated backgrounds for their short videos. What's impressive is that the number of channels uploading short videos increased 50% year-over-year last year. In the U.S., monetization rates for short videos compared to in-stream viewing have more than doubled over the past 12 months, and we believe this will be a major growth driver for future ad revenue.
Significant margin expansion improves earnings outlook
Now let's look at the cloud business. Google Cloud's revenue in Q1 FY24 grew 28.4% year-over-year, accelerating from 25.7% year-over-year growth in the previous quarter. This was mainly due to an increase in average revenue per seat. This growth trajectory looks more robust compared to Amazon's (AMZN) AWS, which grew 17.2% in Q1 FY24, up slightly from 15.8% year-over-year growth in Q1 FY23. Over the past three years, Google Cloud's EBIT margins have been expanding, which, combined with a return to revenue growth, is a positive sign. Meanwhile, strong EBIT expansion in Google Services helped the company's overall EBIT margins rise to 31.6%, its highest since Q3 FY21. This led to the company's GAAP EPS growing 61% year-over-year in the last quarter, accelerating from 56% year-over-year growth in Q4 FY23. While we acknowledge that the margin expansion is largely due to a year-over-year decrease in operating expenses, revenue is still growing at a solid pace, which could justify an expanded valuation multiple.
Capital spending on AI infrastructure in 2024 will increase 52% year-over-year
It should be recognized that all growth comes with a cost. As shown in the chart, GOOGL's capital expenditures as a percentage of total revenues have been increasing since Q3 FY23. In Q1 FY24, capital expenditures increased nearly 100% year-over-year to $12 billion. Management expects quarterly capital expenditures to be approximately $12 billion or more throughout the year. Assuming $12 billion in each of the next three quarters of FY24, total capital expenditures in FY24 are expected to increase 52% year-over-year to $48 billion from $32.3 billion in FY23.
When an analyst asked GOOGL President and CIO Ruth Porat about the company's recent increase in capital expenditures despite its long-term investments in AI, she suggested it was mainly due to the Gemini foundation model. The company also expects investments in office facilities to be less than 10% of total capital expenditures in 2024. Therefore, we believe GOOGL will maintain its current growth trajectory through its significant investments in GenAI and continued monetization of AI innovations over the long term.
evaluation
Despite the stock recently reaching an all-time high, I believe GOOGL is still undervalued. It currently trades at 28.5x GAAP P/E TTM, which is in line with its nearly 10-year average. This multiple is slightly below the S&P 500 Index's P/E TTM of 28.7x. According to Seeking Alpha, it trades at a non-GAAP P/E forward of 24.8x, which is 4% below its five-year average. Given GOOGL's returning growth in its core advertising business and strong margin expansion driven by increased capital expenditures in AI innovation, its non-GAAP forward P/E is the lowest among the “Magnificent 7” (which includes Meta (META) at 25.4x, MSFT at 39x, AMZN at 43x, NVDA at 47x, TSLA at 97x, and AAPL at 33.6x). Therefore, I believe GOOGL is the most undervalued AI stock among the “Magnificent 7” with plenty of room for upside from current price levels.
Conclusion
In summary, GOOGL is leveraging its GenAI monetization strategy to drive significant growth across its product ecosystem. This move has already fueled strong stock price appreciation, supported by strong revenue growth driven by accelerating revenue growth in Google Search and YouTube Ads, as well as continued Google Cloud margin expansion. Despite the recent stock rally, GOOGL remains the most undervalued stock of the Magnificent 7 from a non-GAAP P/E forward perspective, trading at 24.8x, and is poised for further upside as the company continues to innovate and invest heavily in AI infrastructure in FY2024. Therefore, I maintain my Buy rating on the stock.
Sources 2/ https://seekingalpha.com/article/4702546-google-alphabet-cheapest-stock-in-magnificent-7 The mention sources can contact us to remove/changing this article |
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