Is Alphabet Stock a Smart Buy After Recent Surge?

Alphabet's stock saw a notable increase following a strong earnings report for the third quarter.

Despite the end of Halloween, there are unsettling trends in the markets that cannot be overlooked. Instead of frightful creatures, the troubling sign is the red numbers dominating the market lately.

With the arrival of third-quarter earnings season and an impending presidential election, uncertainty abounds, leading to widespread sell-offs in stocks, which is concerning.

However, one stock that has demonstrated resilience amidst this volatility is Alphabet (GOOGL -1.20%) (GOOG -1.14%), recognized for its powerhouse in artificial intelligence (AI) and a member of the "Magnificent Seven" group. Following its impressive earnings results announced on October 29, shares of Alphabet surged by as much as 10%.

In this article, we will delve into the key aspects of the company's earnings and evaluate whether now is an advisable moment to purchase Alphabet shares.

What is Driving Alphabet's Stock?

For the quarter ending September 30, Alphabet reported revenues of $88.3 billion, marking a 16% year-over-year increase when adjusted for constant currency. Furthermore, the operating income surged by 32% year over year, totaling $28.5 billion, along with a substantial free cash flow generation of $17.6 billion.

Alphabet's primary revenue and profit source comes from its vast advertising division, anchored by its search engine Google and the video platform YouTube. Sales from Google and YouTube each grew by 12% compared to the previous year in the third quarter, fueled in part by increasing advertising spending due to the presidential election.

Notably, Alphabet has also made significant strides in subscription services and cloud computing. The Google Cloud Platform (GCP) emerged as the company’s fastest-growing segment, boasting a 35% year-over-year sales increase, reaching $11.4 billion.

Management credited the growth of Google Cloud to advancements in generative AI. CEO Sundar Pichai emphasized that the company's leadership in technology and its AI portfolio are driving new customer acquisition, larger deals, and increased product adoption by 30% among existing clients.

By integrating AI into its entire product suite—including search, video, productivity, and cybersecurity—Alphabet is enhancing customer engagement and retention, which plays a crucial role in strengthening its platform.

Evaluating Alphabet's Valuation

When comparing Alphabet with a significant competitor, Microsoft, based on the forward price-to-earnings (P/E) ratio, it becomes clear that investors apply a higher valuation multiple to Microsoft. Alphabet's forward P/E stands at 21.4, which is slightly below the average of around 23 for the S&P 500. This gap may indicate that investors perceive Alphabet's near-term financial outlook as less promising compared to the overall market.

Given Alphabet's current growth trajectory and increasing significance in the AI space, one might find these valuation discrepancies puzzling, but there are reasons that rationalize such differences.

Considerations for Investors

Even though Google and YouTube remain at the top of the online platform hierarchy, Alphabet faces stiff competition.

Meta Platforms commands a combined audience of 3.3 billion daily active users across Facebook, Instagram, and WhatsApp, presenting lucrative alternatives for advertisers. Additionally, the rise of TikTok has emerged as a formidable competitor, particularly among younger users.

Moreover, the introduction of new search tools by services like ChatGPT poses a long-term challenge for Alphabet. If ChatGPT attracts users away from Google, it could significantly impact Alphabet’s advertising revenue. Also, with Microsoft investing in ChatGPT, they might reap benefits from its growing influence in search functionalities.

While Alphabet stock might seem appealing at first glance, considerable uncertainties regarding the company's long-term potential linger. This unpredictability is likely contributing to Alphabet's comparatively lower valuation against its competitors.

So, should investors consider adding Alphabet to their portfolios? On one side, the company is making remarkable advancements in its core offerings backed by considerable AI investments. Yet, the competitive landscape for the company’s primary revenue streams is intensifying.

For these reasons, it may be prudent to forgo purchasing Alphabet stock for the moment while keeping an eye on how the AI environment evolves.

Alphabet, Stock, Earnings