Bill Ackman's sole technology holding is a great buy on the heels of the AI revolution.
One of the most closely followed investors on Wall Street is Bill Ackman, CEO of Pershing Square Capital Management. While Ackman's portfolio contains billions of dollars of investment capital, the hedge fund manager only owns seven individual stocks.
There is only one technology company in this small group: the “Magnificent Seven” member the alphabet (GOOG 9.96%) (GOOGL 10.22%). Earlier this month, Oppenheimer's Jason Helfstein raised his price target on Alphabet stock to $185 — about 17 percent from current trading levels after the market closed on April 22.
Let's explore why Ackman and others on Wall Street believe so strongly in Alphabet and assess whether now is a good opportunity to pick up some shares.
Advertising is a cash cow, but…
Alphabet's primary revenue and profit drivers come from advertising. Considering that the company owns internet search website Google and video sharing platform YouTube, it's safe to say that Alphabet has a huge online presence.
The table below illustrates the growth trends in Alphabet's advertising business over the past several years.
| Kind of | 2023 | 2022 | 2021 |
|---|---|---|---|
| Google Search and others | 8% | 9% | 43% |
| YouTube Ads | 8% | 1% | 46% |
| Google Network | (4%) | 3% | 37% |
| Total Google Advertising | 6% | 7% | 43% |
Data Source: Alphabet Investor Relations
In recent years, Alphabet has been forced to fight off a number of competitors encroaching on its advertising business. Meta platforms Owns several social media applications including Facebook, Instagram and WhatsApp. Moreover, TikTok's growing popularity has also affected Alphabet's appeal to advertisers.
Yet, despite slowing growth in its biggest business, Alphabet remains extremely profitable. It's this dynamic that I think investors are miscalculating.
Certainly, the advertising sector is witnessing an existential crisis. However, Alphabet's strong operating margins continue to trickle down. And the company is making some smart investments in new growth drivers that are already paying off.
GOOGL operating income (quarterly) data via YCharts.
Artificial intelligence (AI) is the new driver of growth.
In addition to advertising, Alphabet has a services business and a cloud computing operation. The Services segment includes YouTube TV and NFL Sunday Ticket subscriptions, purchases from the company's App Store, and sales of devices such as the Google Pixel phone.
Investors should be interested to know that the services business is highly profitable — generating $95.6 billion in operating income in 2023, up 16% year-over-year. Moreover, the cloud division is now consistently profitable. Last year, Alphabet's cloud segment reported a $1.7 billion operating profit, compared to a $1.9 billion loss in 2022.
One of the main reasons why Alphabet has been able to generate consistent, strong profitability metrics across many different areas of its business is thanks to AI.
In his 2023 shareholder letter, Ackman outlined that Alphabet's “competitive positioning in AI has underpinned the high-quality nature of its business and strong growth prospects.” This is a good way to point to some investors who are seeing better opportunities in AI than Alphabet.
However, the trends explored above undermine Eckman's position when it comes to Alphabet's business model. As the company continues to integrate AI throughout its ecosystem, investors should begin to see rapid increases in the company's revenue and profit margin profiles across the many different sectors in which Alphabet operates.
Image source: Getty Images.
Is now a good time to invest in Alphabet?
As of the time of this article, Alphabet's price-to-earnings (P/E) ratio of 26.9 is the second-lowest of the Magnificent Seven — slightly above apple.
Moreover, the company's price-to-free cash flow is essentially in line with Alphabet's 10-year average. Considering how much Alphabet has grown over the past decade and how different the company is today than it was 10 years ago, I think investors are discounting future growth opportunities too much.
GOOGL price for free cash flow data via YCharts.
I think there is now a profitable opportunity to buy Alphabet on an underrated AI narrative. The stock looks cheap compared to its peers, and with so much potential, it's hard to move.
Suzanne Frey, an Alphabet executive, is a member of The Motley Fool's board of directors. Randy Zuckerberg, former director of market development and spokeswoman for Facebook and sister of MetaPlatforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Adam Spatiko has positions in Alphabet, Apple and Meta Platforms. The Motley Fool has positions in and is recommended across the Alphabet, Apple, and Meta platforms. The Motley Fool has a Disclosure Policy.