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It’s hard to know what to think about Google and its parent company Alphabet. (And it seems wrong just to “Google” it.) This titan of search, cloud, and mobile keeps growing its prominence in our online lives and coming up with groundbreaking innovations – its super-powerful quantum computer is just the latest. But it’s also facing two very real threats: one from generative AI and the other from an antitrust case that could force this giant’s breakup.
And that’s taken a toll on its stock valuation. So with its shares now among the “cheapest” in the Magnificent Seven, I decided to crunch some numbers and find out whether this might be a magnificent time to buy. Here’s how I did it, along with the models you can use to make your own assessment.
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This “Magnificent” behemoth is essentially divided into three mildly interconnected segments – Services, Cloud, and Other Bets. Of those, the Services unit is the biggest, fueled by Search. Cloud, meanwhile, is the fastest-growing, fueled by the AI boom.
Google Services is the most important of the three segments and includes popular things like Search, YouTube, Android OS, Chrome, Maps, Photos, Play, advertising, and devices (including the Pixel family). It generates revenues primarily from advertising. When you use its highly ubiquitous search engine, its algorithm gives you the most relevant results while also gaining an improved understanding of what makes you tick. And because advertisers want their names to be seen by as many potential customers as possible, they pay Google to position their links prominently on the results page – whether you click on those links or scroll by them, Google makes money.
Google Cloud includes computing, data storage, data analytics, cybersecurity, and generative AI solutions and machine learning, along with other services for business customers. Cloud has been on a tear since the start of the AI boom, with sales increasing 26% in 2023, and expected to jump 30% this year and next.
The Other Bets division, meanwhile, is a group of high-risk, high-reward moonshot programs – including companies like GFiber, Calico, CapitalG, GV, Verily, and Waymo. The division doesn’t make money on its own, but thanks to Alphabet’s strong balance sheet, it can afford to invest in speculative projects. Waymo, the autonomous vehicle company, was valued in a funding round this year at $45 billion.
The firm makes nearly half its money in the US, and nearly a third in Europe, the Middle East, and Africa.
Two major issues have made investors nervous about Alphabet’s profit prospects and strategy. First is that AI-powered web engines have been shaking up the search market, threatening Google’s dominance. Second is that US antitrust regulators have turned up the heat: they’ve recently said the firm should be forced to sell off Chrome, and potentially Android. Google is pushing back hard on both fronts, but the uncertainty around this battle has put pressure on investor confidence and the stock’s valuation.
Alphabet has had an edge in search for a long time – a competitive moat that has kept its rivals at bay, Initially, that was because of its superior search technology, but eventually, it was because of consumer habit. Today, Google holds a nearly 90% share of the global search market. Now, one of the major concerns is that those competitive barriers to search are being chipped away by advances in generative AI – highly trainable large language models that can answer web users’ questions. OpenAI’s ChatGPT, Perplexity, and Anthropic’s Claude AI are all aiming to disrupt the search market – as are several others. And these technologies could well change how consumers search.
Generative AI chatbots are seeing exponential growth. And, yeah, ChatGPT is still the market leader – boosted by its first-mover advantage – but its growth rate has eased as Google has launched Gemini and Microsoft has improved its AI assistants.
Google’s not simply going to roll over and give up its lead – it’s investing heavily to improve its Search offering. Its new Google Lens feature now has over 20 billion visual searches per month and is popular among younger users. And sure, Bard – the company’s initial AI launch – ran into some snags when it debuted in 2023, spewing out wrong answers and false information. But the much improved, updated Gemini version is making up for that. It’s simply much better at its job, having been trained on a way bigger dataset. Gemini is doing so well, in fact, that it’s now being used on all of the company’s products and platforms.
For example, in Google Search, it creates the “AI Overview” (AIO) – summarizing information from multiple sources automatically, rather than just providing links to websites. That’s changed what you see at the top of the web search results page.
AIO aims to provide a richer response to your query and is being rolled out gradually to ensure a smooth launch. Links in AIO are more prominent, and show site names, headings, snippets, and sometimes images – all packaged in a card-like format that aims to attract clicks. So far, advertisers like it: they’re generally willing to continue paying for prominence on the new results pages. After all, with fewer clickable targets, they’re more likely to get customer traffic.
Google’s crack team of engineers has reduced Gemini’s computing expenses – i.e., its “costs of “inference” – by an impressive 90% over the past 18 months, while doubling the size of Gemini. That’s a big deal: see, margins on search results using AIO are lower because the costs to process search results are higher. So the firm has looked to offset the outlay, by charging customers for their use of its most advanced AI services – a first for the company. That approach looks like it may become the norm – ChatPT also announced a fee schedule last week for customers who want to access its ChatGPTPro service.
According to research, AIO provides a better user experience than the old method, and that suggests the total search market could grow. So Google is starting to embed Gemini’s powerful AI features into its products. The tool could become the standard for Samsung, Xiaomi, and other Android phone manufacturers – and for all of Google’s Pixel devices, which would put Gemini’s powerful features in the hands of millions of users.
Antitrust regulators have taken aim at Google’s search – accusing it of maintaining a monopoly on search and asking a federal court to slap some serious consequences against the Big Tech giant. Among other things, the Department of Justice (DoJ) is asking the judge to force the company to sell off its Chrome web browser. That didn’t go over well with investors: Alphabet’s share price fell 5% in reaction.
Here’s what the feds are recommending:
1) The forced sale of its Chrome browser. The DoJ is also requesting that the company not be allowed to re-enter the browser market for five years. The regulators say the company may need to divest its Android mobile operating system too if certain recommended competitive remedies don’t do enough to curb its dominance.
What’s the potential impact here? The browser is core to Google’s search business. It’s free to download but provides the firm with the all-important data it needs to deliver targeted ads to consumers. According to court documents, 20% of Google’s search traffic comes from Chrome. That’s a lot: a little back-of-the-envelope math says that could be worth $40 billion a year. So selling off Chrome could deliver a serious – and immediate – blow to Google Search revenues.
The DoJ also wants Google to stop leveraging its ownership of the Android OS to its advantage in Search – and has argued that it should be forced to sell Android if it won’t do so. If that happens, a standalone Android business would have to create new agreements – since it’s also currently offered for free.
2) Data sharing with the competition. Google would have to open up, revealing the data it has stored, the models it deploys for search, and the ranking signals it uses to power search results. And that means divulging all those secrets to rivals and other folks for up to ten years, at a marginal cost.
What’s the potential impact here? Such a move would undermine Google’s competitive edge, but it’s not clear by how much. That will depend on which search competitors would be allowed to license the data and under what terms. The firm already has results-sharing agreements with some third-party search engines, so the fallout might not be as devastating as you might think. Still, one simple way to ballpark the likely impact is to compare it to the 10% – or $10 billion – Meta lost in advertising revenue after Apple started requiring stricter privacy settings on iOS. So: 10% of Google’s 2024 advertising revenue would be a hit of about $26 billion.
3) A ban on search pre-install deals. These are long-standing arrangements in which Google pays a hefty compensation to Apple, Samsung, and others for exclusive default search engine positioning. It’s why your new phone doesn’t send you to Bing or DuckDuckGo.
What’s the potential impact here? It's unclear how the rules would be enforced. Court filings suggest that close to 50% of Google search traffic comes from distribution partners, so it’s not small potatoes. But as Google pays a chunk of money for those priority installs, there’d be modest savings here too. In 2023, the company paid about $50 billion in traffic acquisition costs (TAC), from total revenues of $307 billion.
The federal judge in Alphabet’s case could decide to force all third parties to display a “choice screen” on devices and browsers, allowing users to select their preferred search engine. But that probably wouldn’t be the worst news for Google: a lot of people would likely continue to choose its browser over all the others. At least, that’s what has happened in Europe since 2020, when a similar choice screen was put in place. Come to think of it, since that change already has a record of not denting Google’s dominance, it’s pretty unlikely that the US judge will impose it as a fix.
The far bigger risk for Google is that Apple could enter a new agreement with another search engine, like Bing or SearchGPT, in a deal that’s structured like the existing one with Google (i.e. with payments made for exclusive default positioning on iPhones, iPads, and other devices). Google’s internal analysis estimated that being replaced as the exclusive default search engine on Apple devices could result in an iOS query volume drop of as much as 80%.
Of course, this is all far from settled. Alphabet is due to submit a counter-proposal to the DoJ this month, a hearing is set to begin in April to address the proposals, and a final ruling is expected in August. Google has said it will appeal the initial judgment and any remedy ruling, so the process could drag out for another two years.
An added uncertainty to the outcome is the new administration that is set to take office in January. The president-elect has expressed concerns about Google’s market power but has stopped short of calling for a breakup. That said, he recently nominated a pro-enforcement attorney to the DoJ’s top antitrust post, which suggests that the Big Tech crackdown is likely to continue.
You can slice and dice a stock’s valuation using several different metrics. And Alphabet looks cheap across three of the most useful ones: price-to-earnings ratio, sum of the parts, and discounted cash flow analysis. That said, the antitrust case could result in remedies that produce a sharp, downward revision to Google’s future revenues and profit expectations – and that could plunge its bottom line.
Alphabet’s two big threats have been weighing on its valuation. That’s not to say its stock’s performance has been bad – it’s up 24% so far this year. But before you put your hard-earned money into anything, it’s good to recall those words of wisdom from Warren Buffett: “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Valuations and assumptions
Google’s Services division remains the company’s core business driver and I estimate it will grow its revenues by around 11% this year when all is said and done – and by a similar amount in 2025. YouTube advertising sales appear poised to grow by 14% this year, and next, ending 2025 around $41 billion. Viewing time on YouTube has been rising, boosted in part by the growth in Shorts (similar to Meta’s Reels).
And Cloud – a.k.a. Google’s fastest-growing business – has seen its revenues grow roughly 30% so far this year, and I estimate a similarly speedy rate for 2025, thanks to AI and overall cloud demand. That would jump Google Cloud’s revenues from $33 billion in 2023 to $43 billion in 2024 and $56 billion in 2025.
On the other hand, Traffic Acquisition Costs (TAC) – those third-party deals with device-makers like Apple and Samsung – are estimated to rise to around $55 billion in 2024, and $60 billion in 2025. Those costs are calculated by multiplying advertising revenues by about 21%. And some continued capital expenses – namely the more than $50 billion the company has devoted to AI this year alone – will have an impact. As much as half of that total is estimated to have gone to fellow Magnificent Seven member Nvidia, for its AI-powering chips. And, yes, these are huge price tags, but these things are driving efficiency gains – improving profits, margins, and free cash flow.
On the tax side of things, Alphabet pays an attractively low rate, thanks to its global network of companies. It paid 13.9% in 2023 and is expected to owe 16.2% this year. I’d assume a rate of 17% in 2025. So you can estimate a net income (or overall profit) of about $110.9 billion in 2025. We built you this template to demonstrate how it all shakes out. (Just note that you’ll need to make a copy of it before you can fiddle around with the cells.)
Now that you have a full view of what’s going on at Alphabet, let’s look at its valuation – eying it from three different angles.
The price-to-earnings ratio
This is the most common tool used to measure a stock’s valuation, so it’s a good place to start. Put simply, the price-to-earnings (P/E) ratio is calculated by dividing the market value price per share by the company’s earnings per share.
Back in December 2014, the company (blue line) traded at a higher P/E ratio than the S&P 500 (yellow line). That premium eventually disappeared: the stock now trades at just 21x this year’s profits, a significant discount to the S&P 500’s 27x and only slightly higher than the Equal Weight S&P 500 Index (orange line) – which is a better comparison to the overall market, because it dilutes the heavy tech weighting of the straight-up index. Based on 2025 estimates, Alphabet’s earnings per share are $9.02, equivalent to a P/E ratio of 19x.
The Sum of the Parts value
A sum of the parts (SOTP) valuation – appropriately known as a “break-up analysis” – is a way to determine the value of a company by sizing up what each of its business segments is worth and then adding those together. So in Alphabet’s case, by using the above estimates, assumptions on profit margins, peer multiples, and a 17% tax rate, you can calculate the valuation for the Core Service business for 2025.
Here are the points you’ll need:
Taking Alphabet’s estimated total net income of $110.9 billion for 2025, subtracting forecasted net income from Google Cloud, YouTube Ads, and net interest income, and adding back losses from Other Bets, you find that Google core services' contribution to 2025 net income will be around $96.6 billion.
The estimated market value of Google Cloud, YouTube Ads, Waymo, Other Bets, and the net cash is around $707 billion. With the current market capitalization of Alphabet standing at $2.1 trillion, that leaves about $1.4 trillion of market cap to be attributed to Google’s core services. And if you divide that by $96.6 billion, (core services’ net income contribution), you get a price-earnings ratio valuation of 14.4x for Google’s core services.
That looks low – but there are two important caveats to consider. First, investors just aren’t confident about what profits will look like in the future, once the antitrust ink dries. And, second, holding companies usually trade at a discount to the SOTP – sometimes significant discounts – because rarely is that value realized. Still based on P/E and SOTP, Alphabet looks cheap.
Discounted Cash Flow
A discounted cash flow analysis also shows just how cheap it is: suggesting that Alphabet has around 15% upside to fair value, to $200. You can access the model here, but like the one earlier, just remember you’ll need to make a copy to play around with the assumptions. I used the estimates from above for 2024 and 2025, and assumed that revenues would increase by 11% per year, and then, thanks to the high capital expenditure being made on AI, I penciled in an increase in depreciation charges. Again this is only a base-case scenario, without any nasty antitrust fallout.
For example, if you assume that a relatively severe judgment is handed down, that could result in a $96 billion hole in net revenues. That’s a $40 billion hit based on the 20% of Google’s search traffic that comes from Chrome, according to the DoJ. And a $26 billion impact from advertising sales (or roughly 10%), if the giant were forced to share data. It also factors in a $30 billion net hit from a potential ban on search pre-install deals.
And if you imagine that growth slows to a less-robust 8% and that the terminal enterprise value to earnings before interest, taxes, depreciation, and amortization (EV/EBITDA) multiple drops from 13x to 11x, the stock’s fair value would be in the neighborhood of $144, down 31% from where it sits now. You’ll find this scenario here in this sheet – in the tab “DCF bear case”.
The fact that Alphabet’s not trading at those levels tells you that investors are expecting an antitrust outcome that’s not quite so bad – one with just moderate downside risk. That makes sense – Alphabet, like its ubiquitous search engine, is widely followed and widely used, so you would expect the market to accurately reflect some of the current risks.
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