Alphabet after last week's earnings report.
The "Magnificent Seven" dominated the stock market since the launch of ChatGPT in late 2022, and it's easy to see why.
These seven stocks, which include Alphabet (GOOG 0.43%) (GOOGL 0.20%), Microsoft, Apple, Nvidia, Amazon, Meta Platforms, and Tesla, are the largest U.S. tech stocks on the market, and all play various roles in the artificial intelligence (AI) revolution.
This elite group of stocks now makes up roughly a third of the value of the S&P 500, but their gains haven't come purely from increased earnings. Valuations have gotten stretched along the way, and of the seven stocks, only two trade at a discount to the S&P 500, which is valued at a price-to-earnings (P/E) ratio of 28.4. Those are Meta Platforms, which currently trades at a P/E of 25.4, and Alphabet with a P/E of 24.5, which is about as cheap as it's been in the last year.
Alphabet stock fell after its second-quarter earnings report last week due to slower-than-expected growth in YouTube and concerns about spending on artificial intelligence, and the stock is now down 7% since before its earnings report came out. Should you buy Alphabet on the dip?
Let's take a look at whether this Magnificent Seven stock is a bargain or if it's better off avoided.
Alphabet's latest numbers
While the Google parent fell on its latest report, the results were generally strong. Revenue rose 14%, or 15% on a constant currency basis, to $84.7 billion -- although, that did represent a modest deceleration from Q1's growth.
Profit growth was strong as well, as operating margin rose from 29% to 32%, and earnings per share jumped from $1.44 to $1.89. The search giant is still benefiting from layoffs last year as its headcount was down slightly from a year ago, helping to boost margins. Google Cloud is also emerging as a source of profit after years of losses, posting an operating profit of $1.17 billion in the quarter. The vast majority of its profits still come from digital advertising with search generating nearly 60% of revenue.
Investors were displeased with 13% revenue growth from YouTube, below estimates at 16%, but the biggest reason for the sell-off seemed to be the jump in capital expenditures (capex), which were up from $6.9 billion to $13.2 billion as the company races to build out data centers to ramp up its AI capabilities. Management said on the call that it's committed to investing to maintain its technical leadership in AI and the cloud.
Fears about overspending in tech come as even Meta Platforms CEO Mark Zuckerberg acknowledged that the industry may be overspending on AI infrastructure. However, Alphabet is so profitable that the company is better off overspending to keep up with the new technology than to risk getting left behind.
It's facing new competition, including SearchGPT, the new AI-powered search engine launched by OpenAI just last week.
Alphabet's search business remains dominant, but in order to maintain its lead, the company will have to invest in its tech infrastructure to make its large language models and other AI tools competitive with rivals like SearchGPT. In that context, the increased spending makes sense even if investors would rather see that cash be returned to shareholders.
Is Alphabet stock a buy?
It's been close to two years since ChatGPT launched, and Alphabet has acquitted itself well after early concerns that it would get left behind by OpenAI, which is backed by Microsoft.
However, the Google parent has defended its internet search dominanceand kept up with the emerging technology.
The stock has a history of rewarding dip buyers, and the recent sell-off, though modest, seems worth taking advantage of. After all, Alphabet is growing revenue and profits much faster than the S&P 500, yet it's trading at a discount to a broad-market index.
The increase in AI infrastructure spending shouldn't dissuade you from buying the AI stock today.
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Jeremy Bowman has positions in Amazon and Meta Platforms. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla. The Motley Fool recommends the following options: long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
