You wouldn’t know it from the many negative headlines about the lower-than-expected revenue of Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Google Cloud business last quarter, but advertising accounts for most of the firm’s revenue. And, in line with my previous predictions, the growth of the company’s advertising revenue meaningfully accelerated last quarter as fears about a recession in the U.S. considerably eased. This is a big tailwind for GOOG stock.
Also noteworthy is that Google Cloud has become profitable, while artificial intelligence looks poised to lift Alphabet’s sales over the longer term meaningfully. Finally, the valuation of GOOG stock is now relatively low.
Given these points, I recommend that investors buy GOOG stock on weakness.
Alphabet’s Ad Business Has Meaningfully Accelerated
In 2022, 81% of Alphabet’s revenue came from advertising, while Google Cloud only accounted for about 8% of the conglomerate’s sales.
And last quarter, the revenue of the company’s two largest ad businesses–Google Search and YouTube — jumped 11.4% year-over-year and 12.4% year-over-year, respectively. That was way above the 5% and 4% YOY growth the businesses generated in Q2. Moreover, the company’s overall ad revenue climbed 8.5% year-over-year in Q3, representing the most robust growth since Q2 of 2022.
In light of the sharp acceleration of Alphabet’s ad business last quarter, I’m not surprised that its earnings per share climbed to $1.55 last quarter from $1.44 in Q2.
“You’re seeing performance in search led by the retail vertical, and then we’re excited about what we’re seeing in YouTube ads, the acceleration and growth from brand advertising and direct response,” CFO Ruth Porat told Fox Business.
Google Cloud Is Growing Rapidly and Has Become Profitable
Google Cloud generated revenue of $8.4 billion in Q3, slightly below analysts’ average estimate of $8.64 billion. However, the unit’s revenue still increased 22% versus the same period a year earlier. While the latter gain represented a meaningful deceleration from the 28% YOY jump that the unit generated in Q2, it still represents a relatively robust increase.
Moreover, Google Cloud generated an operating income of $266 million last quarter, which was way better than the operating loss of $440 million the business reported in Q2 of 2022.
Also importantly, despite all the attention given to Google Cloud’s performance, the unit provided only 2% of Alphabet’s profits last quarter.
AI Can Be a Game Changer for GOOG Stock
AI is poised to make Google’s search engine much more powerful and valuable in multiple ways. Consequently, I believe that the amount of time users spend on Google will ultimately increase significantly, enabling it to attract meaningfully more ad revenue and lift GOOG stock.
For example, Alphabet uses AI “to create summaries” on Google in response to “some search questions,” Along with these AI-generated summaries, the search engine provides website links. That sounds like a much easier way to quickly find good, responsive results than the current system of scrolling through many headlines with descriptions that may or may not be related to users’ queries.
Further, Alphabet is using AI to greatly improve Google Maps, and those changes could make Maps much more popular among consumers, significantly increasing the ad revenue that the app generates.
Finally, as I reported in a previous column, Alphabet now owns 2.5% of GitLab (NASDAQ:GTLB), which is using AI to make computer programming much more straightforward. Ultimately, Alphabet can be helped by the likely high utility of GitLab’s tools by using them and benefiting financially from the gains of GTLB stock. Alphabet could also ultimately buy GitLab, enabling its profits to be boosted by GitLab’s business.
The Valuation of GOOG Stock Is Attractive
Analysts, on average, expect Alphabet’s EPS to jump to $6.29 next year from $5.31 this year and $4.56 in 2022. But despite Alphabet’s strong growth, its shares are changing hands at a roughly average forward price-earnings ratio of 18.9.
As a result, GOOG stock is a bargain at its current levels.
As of this writing, Larry Ramer did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.