Since early February, when Google-parent company Alphabet (GOOGL) reported its Q4 results, the stock has been treading water, significantly underperforming the S&P 500 (SPY), and struggling to register new highs. The main concerns currently weighing on Alphabet investors boil down to a potential slowdown in the company’s primary revenue driver, Google Search, and sluggish growth in Google Cloud, supposedly its fastest-growing segment.
As a long-term Alphabet bull, I believe these concerns are short-term issues. Alphabet’s Search segment continues to grow at double-digit rates, benefiting from AI trends rather than being hurt by them. Meanwhile, the slowdown in Google Cloud growth doesn’t impact margin gains, which should be the primary growth engine for the company’s bottom line for years to come.
In addition, news hot on the wire suggests that Alphabet’s co-founder Larry Page is setting up a new AI firm called Dynatomics, aiming to “revolutionize manufacturing.”
At current valuations, Alphabet shares are trading at forward earnings well below their historical average over the last five years and at almost identical levels to September last year, which was the previous price bottom before a strong rally until early February. So, assuming no significant structural changes to Alphabet’s fundamentals or growth story, this could be a solid buy-the-dip opportunity.
Google Search Embraces AI
Starting with Search, the rise of AI has raised concerns about how it could impact Google’s search business, especially with the emergence of LLM models like ChatGPT. The initial worry was that users might start searching more on these platforms to get direct answers without the commercial bias and ads, Google is known for.
Let’s not forget that Alphabet is primarily ad-driven, with Google Search accounting for 56% of its revenues in Q4 2024. While Google Cloud has been the focus of Alphabet’s growth story lately, some investors seem to overlook that Q4 still marked the sixth consecutive quarter of double-digit annual growth for the Search segment, with revenues up 12.5% year-over-year, despite a slight slowdown from the first two-quarters of FY2024.
So, investors need to recognize that Google Search, a $200 billion-a-year business, is still growing strongly, even with the rise of new AI platforms. In fact, Alphabet has managed to turn the AI challenge into an opportunity. The company has invested billions in developing its own AI, and it’s now using its own tools to benefit its business—whether it’s for coding, automating processes, or improving efficiency.
Alphabet’s management also pointed out that they recently launched advertising within AI overviews on mobile in the U.S., building on their previous efforts with ads above and below AI overviews. The key takeaway is that monetization from these ads is happening at roughly the same rate as it did with regular Google search results. While there’s still room for further innovation, it’s clear that Google Search is countering the AI threat and using it to its advantage—continuing to grow by double digits.
Unpacking the Growth Slowdown in Google Cloud
Another point of skepticism that came up after Alphabet’s Q4 earnings report is the slowdown in Google Cloud’s growth. The sales growth rate has dropped for the first time since Q2 2023, falling from 35% in Q3 to 30% in Q4.
Although the segment still hit new all-time high revenues, Google Cloud remains far behind in market share. It holds about 12% of the global cloud market, compared to Amazon’s (AMZN) AWS with 30% and Microsoft’s (MSFT) Azure with 21% (which grew 31% last quarter). This slowdown was concerning for a company that had been growing faster to catch up with its peers.
However, it’s important to note that Google Cloud consists of both Google Cloud Platform (GCP)—Alphabet’s core cloud services—and Google Workspace. According to Alphabet’s management, GCP has been growing much faster than the overall cloud segment—over 30%. This means GCP has been growing faster than AWS, especially Azure last quarter.
Alphabet’s Margins and Custom Chip Strategic Edge
One of Google Cloud’s standout accomplishments recently was a noticeable increase in operating margins in Q4. Google Cloud posted a margin of 19% in Q4, a significant jump from 11% in Q3, though still far behind the impressive 37% margin reported by AWS in the same quarter.
That said, there are strong reasons to believe that Google Cloud’s margins could continue to rise, potentially surpassing its competitors in the near future. One major factor is Alphabet’s growing reliance on its own chips for internal workloads, like running Google Search and other services.
To avoid being too dependent on Nvidia’s (NVDA) GPUs, Alphabet has ramped up production of its own custom chip, called Trillium, which is a Tensor Processing Unit (TPU). The sixth generation of Google’s TPU, which is known for its improved performance, delivers four times better training performance and three times greater inference throughput compared to the previous version. It’s important to note that Alphabet does not necessarily compete directly with Nvidia regarding efficiency. But, it’s providing a more cost-effective option for businesses that need cloud computing power but don’t require Nvidia’s top-tier performance. This gives Alphabet a low-cost solution, which could be a significant advantage in the long run.
While Alphabet doesn’t share detailed comparisons between TPU adoption and Nvidia’s GPUs, it’s clear that Google is positioning itself firmly in the custom silicon (own specialized chips) race alongside its main hyperscaler competitors.
Alphabet’s independence from other Big Tech companies can be seen as a competitive edge. It allows the company greater control over its AI infrastructure, resulting in better price-to-performance ratios for its cloud services. In turn, this could lead to gaining market share and also boost operating margins.
Is Alphabet a Buy, Hold, or Sell?
Overall, Wall Street analysts have a bullish outlook on GOOGL stock. Out of the 37 analysts covering the stock in the past three months, 26 recommend a Buy, while 11 suggest a Hold. Not a single analyst recommends Selling GOOGL stock. The average price target for GOOGL stock is $215.56 per share, which implies an upside potential of 25% from the current price.
GOOGL’s Growth Story Is Far from Over
Over the past twelve months, investors who took advantage of Alphabet stock trading below its 20x forward earnings have done well, as the stock has rapidly rebounded from those lows. In my opinion, the overly pessimistic reaction after Q4—especially regarding Search—doesn’t match reality.
Despite Search still growing at double digits and Google Cloud’s growth slowing down, the slowdown isn’t due to a lack of demand. It’s more about supply constraints, and the long road ahead for consistent market share growth and higher margins in the cloud business is what investors should focus on. I believe this is another excellent opportunity to go long on GOOGL stock.