Alphabet Earnings: AI Monetization Continues to Grow as Hardware Sales Boost Results

Key Morningstar Metrics for Alphabet

• Fair Value Estimate
  : $450
• Morningstar Rating
  : ★★★★
• Morningstar Economic Moat Rating
  : Wide
• Morningstar Uncertainty Rating
  : Medium

What We Thought of Alphabet’s Earnings

Alphabet GOOG’s third-quarter results include sales growing 25% to $128 billion. The firm’s operating margins expanded 130 basis points to 31.8%. Google Cloud sales grew 103% to $31 billion, and now constitute 24% of the firm’s top line, up from 15% a year ago.

Why it matters: Alphabet’s overall business continues to be boosted by artificial intelligence. The core search business is proving to be more resilient than many investors feared, up 12%. We attribute this strong growth to AI overviews and AI mode growing total search queries, as well as improving AI-driven ad targeting.

• AI’s main beneficiary, without a doubt, is Alphabet’s cloud business. Not only is the segment’s growth stellar, its backlog, or future contracted revenue, is five times annualized quarterly sales, providing the business great visibility as it invests in AI infrastructure.
• Within cloud, we see TPUs, Alphabet’s AI accelerators, as a key differentiator. As Alphabet moves from renting out TPUs to actually selling them to external customers including Anthropic, and recently Oracle, we expect Google Cloud revenue to meaningfully inflect upward.

The bottom line: We raise our fair value estimate for wide-moat Alphabet to $450 from $433, and continue to view shares as attractively priced. We believe that investors are underappreciating the breadth and depth of Alphabet’s AI monetization and the rapid upcoming growth in Google Cloud.

• We also believe that Alphabet’s vertical integration allows it to absorb AI costs better than peers. Its in-house TPUs, AI models, and co-design of hardware and software enable it to lower its total cost of ownership. As such, we view the cost-led bear argument against Alphabet to be manageable.

Bears say: Search sales decelerated from 17% to 12%, this may signal search advertising in trouble. We believe that the deceleration will remain gradual, allowing Alphabet to maneuver its business and drive the majority of sales from nonsearch businesses within five years.