In our previous article, we underscored Alphabet’s (NASDAQ:GOOG) (NASDAQ:GOOGL) challenging endeavor to maintain its lead in AI, amid stiff competition from formidable opponents like Microsoft (MSFT) and OpenAI. Our critique was aimed at Alphabet’s seemingly sluggish reaction, a cause of our frustration. However, we attended Google’s recent I/O event and left impressed by the company’s demo of many new AI capabilities. In our view, this event could indicate a shift in Alphabet’s approach, hinting at the dawn of a new era marked by a more assertive AI strategy. This article delves into an analysis of Alphabet’s I/O event, its standing in the AI realm, and offers a fresh evaluation of the company’s financial performance and valuation.
What We Learned From Google I/O 2023
In Google’s recent 2+ hour keynote address, which was heavily dedicated to Artificial Intelligence, we saw a notable shift towards generative AI, an area that has stirred significant debate since the launch of ChatGPT. This move appears to be a strategic play to regain control of the narrative around generative AI and consolidate Google’s position in this competitive landscape.
The keynote presentation displayed an impressive array of developments and innovative functionality across Google’s entire suite of products. We believe that this comprehensive approach demonstrates Google’s formidable capabilities in the generative AI space, which should serve to reassure investors about Google’s ability to compete effectively in this arena.
A particularly encouraging highlight from the event was Google’s disclosure of its AI-optimized infrastructure. Offering better performance at costs up to 50% cheaper than competitors, Google’s proposition directly addresses ongoing investor concerns regarding compute costs pressuring gross margins. By offering a more cost-effective solution, Google is not only enhancing its competitive edge but also potentially boosting its profitability, a significant win for investors.
Google’s search developments also leaned positive, indicating an ability to respond to increasingly complex queries. This capability could drive incremental search use cases, further strengthening Google’s core Search business, which has been under scrutiny for its terminal value risk. While the company noted it’s not currently making changes to Search ads, it left the door open for potential ad integration in the GAI snapshot area, hinting at a possible new revenue stream.
Spotlight: Bard
Sissie Hsiao, GM of Google Assistant and Bard, recently presented some significant advancements in Bard, Google’s large language model. Initially launched as an experimental project, Bard has undergone considerable enhancements and now demonstrates proficiency in over 20 programming languages. These languages include widely used ones such as C++, GO, JavaScript, Python, and Kotlin, and even extend to Google Sheets functions. Bard’s capabilities now encompass assisting developers with code generation, debugging, and elucidating code snippets, as evidenced by a Python script that recreates a chess move. In addition, Google has responded to developer feedback by enhancing Bard’s code citations to be more precise, providing specific links to sources when it uses blocks of code from elsewhere.
The application of Bard extends beyond coding tasks. For example, Google is incorporating the ability to export Bard’s responses directly into Gmail and Google Docs, thereby assisting users in drafting emails and documents. The continual development of Bard is apparent in its integration with other tools. Soon, users will have the capability to export and run code directly from Bard to repl.it. The upcoming launch of a dark mode, which can be activated manually or set to follow the user’s OS settings, reflects Google’s ongoing commitment to enhancing the user experience. Furthermore, Google plans to extend Bard’s capabilities by integrating it with Google Apps and partner services, enabling users to perform tasks securely and privately that were previously impossible.
The future of Bard appears exciting, with the language model soon being able to interact with images through integration with Google Lens. Bard will be able to identify relevant images in response to prompts and users will be able to prompt Bard with images. Additionally, Google is exploring Bard’s potential as a research tool. An example was demonstrated where Bard was used to locate colleges with animation programs in Pennsylvania, visualize their locations on Google Maps, organize the results in a table, and add pertinent information such as the school’s public or private status. Google is also planning to enable Bard to interact with various online services, such as Instacart, Indeed, and Khan Academy. With the removal of the waitlist and opening up to over 180 countries and territories, Bard’s reach is expanding, and it is set to support 40 languages in the future, already being available in Japanese and Korean.
Spotlight: Workspaces
Aparna Pappu, VP of Google Work Spaces, unveiled the integration of artificial intelligence into Google Workspace, transforming the platform into a dynamic environment for real-time collaboration. This new application of AI aims to elevate productivity by enabling the technology to act as both a coach and a thought partner for users, augmenting human intelligence and efficiency.
The integration of AI into Google Workspace was demonstrated through a variety of practical examples. The “help me write” feature, currently available in Gmail and Docs, showcased the AI’s capacity to assist with diverse tasks, such as drafting essays, crafting sales pitches, and conducting client outreach. In a striking demonstration of AI’s capabilities, Pappu showed how AI can generate comprehensive job descriptions using only brief prompts, significantly reducing time and effort for HR teams. The AI’s ability to streamline and automate tasks was further illustrated in Google Sheets, where AI was shown to organize the logistics of a dog-walking business, generating a detailed table for clients and pet details. Google Slides also benefited from the integration, with AI able to generate relevant images based on the text within a slide, aiding in visual storytelling.
The announcement of Duet AI for Workspace marks a significant milestone in Google’s vision for AI-augmented productivity. Set to offer generative AI features across Workspace, Duet AI is expected to provide proactive and contextual prompts to users based on their ongoing tasks, enhancing the ability to work more efficiently and intuitively. A live demonstration of Sidekick, an AI-powered side panel in Workspace, underscored the potential of this new feature. Sidekick was shown to read and process documents in real time, offering context-based suggestions and prompts to enhance the user’s work. Whether it’s generating context-relevant questions for a collaborative story project, summarizing conversations for a potluck planning scenario, or creating speaker notes for a professional presentation, Sidekick underscores AI’s potential as a collaborator, setting the stage for a new era of productivity in Google Workspace.
Financial & Valuation
Note: All historical data in this section comes from the company’s 10-K filings, and all consensus numbers come from FactSet.
In the recently reported Q1 earnings, Google presented a performance that was somewhat lackluster. Despite revenue growth of 2.6% y/y to $69.8 billion, which met consensus estimates, the stock declined by -0.2% post-announcement. The lukewarm market reaction may be attributed to the company’s operating margin, which fell to 25.0% compared to 29.5% a year ago.
While the company’s earnings per share (EPS) of $1.17 for the quarter did beat consensus by 8%, it represented a 5% y/y decrease, which could be a cause for concern. Yet, it’s important to note that Google’s revenue growth over the past three fiscal years has been robust, with a compound annual growth rate (CAGR) of 20.4%.
Although the sell-side consensus forecasts a slowdown in revenue growth to 5.8% this fiscal year, it predicts a rebound to 11.1% the following fiscal year. We believe this could provide a catalyst for Google’s performance, assuming the tech giant can successfully navigate the competitive landscape and continue to innovate.
On the bright side, Google’s EBIT margin has increased by 5.2% points over the past three fiscal years, indicating an improvement in operational efficiency. Furthermore, the company has been actively repurchasing shares, reducing the diluted outstanding common shares by 14.5% over the past three years. This aggressive buyback strategy has helped to more than offset shareholder dilution.
However, Google’s recent performance has been underwhelming compared to the broader market. Over the past year, the company underperformed the S&P 500 by -7% points, delivering a negative absolute return of -2.0%. Despite this, Google’s stock is trading 15.7% above its 200-day moving average, suggesting a degree of investor confidence in the long-term prospects of the company.
Google’s PEG ratio for FY2 stands at 1.0, compared to the S&P 500’s PEG ratio of 1.5. This represents a discount of 32.7% and could be viewed as a potential opportunity for value-oriented investors. Although the company does not offer a dividend, its strong return on invested capital of 21.4% is a testament to its effective use of capital.
Conclusion
Google’s recent I/O event unveiled a series of impressive advancements in the field of artificial intelligence. The demonstrations of Bard, Google’s language model, showcased its expanded capabilities in assisting developers and its potential to enhance productivity in various tasks. The integration of AI into Google Workspace further solidifies the company’s commitment to empowering users with intelligent collaboration features. Additionally, Google’s financial performance, while presenting some challenges, continues to exhibit strong revenue growth and improved operational efficiency. Overall, the event signifies a shift in Alphabet’s approach to AI, highlighting their determination to maintain a leading position in the competitive AI landscape. As Google continues to innovate and leverage the power of AI, it presents investors with potential opportunities for long-term growth and value creation.
However, investors should keep in mind that Google is still behind Microsoft in terms of implementing generative AI, as we wrote about last month. It is important for investors to thoroughly assess and consider the risks highlighted in the article as part of their due diligence process.
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