Google Search parent Alphabet(NASDAQ: GOOG)(NASDAQ: GOOGL) is the cheapest stock in the Magnificent Seven, and you might scratch your head about why when looking at its financials. Last quarter, revenue grew 14%, with earnings per share up 22%. Yet the stock trades at 19.5 times this year’s earnings estimates, a lower-than-market multiple.
The reason is that investors fear what the advent of artificial intelligence (AI) will do to Google Search activity, and whether Alphabet’s biggest cash cow will come under threat.
Last quarter’s numbers show that isn’t happening, fortunately. But it doesn’t necessarily mean disruption will never happen.
Yet even if Search growth peters out, it seems Alphabet has another AI fallback plan: Google Cloud.
Even if Search gets disrupted to some degree — though I don’t believe that will happen quickly — it appears Alphabet’s Google Cloud unit could make up the difference…and then some.
Last quarter, Google Cloud grew revenue 32% to $13.6 billion, accelerating from the prior quarter’s 28% growth, while operating margins widened tremendously, nearly doubling from 11.3% to 20.7% over the course of the year. It should also be noted that of the $3.3 billion in incremental revenue relative to last year, $1.65 billion fell to operating profits, so Google Cloud is making operating margins above 50% on every incremental dollar of cloud revenue.
Google Cloud’s backlog also surged 18% sequentially — good for a 72% annualized rate — and 38% year over year to $106 billion. That’s higher than the current revenue growth rate, suggesting the unit could continue to accelerate, or at least keep up its current high growth rates for a while.
There is such hot demand for Google’s cloud infrastructure and such high returns on its assets that management decided to increase its capital expenditure plan for 2025 from $75 billion to $85 billion. And why not? The company is clearly seeing huge demand for Cloud services, and very profitable demand at that. If a business is earning such high returns on incremental investments, it should invest all that it can.
While Alphabet doesn’t break down cloud growth by cohort, it’s likely that a big reason for the strong Cloud growth is demand from premier AI unicorns. On the second-quarter conference call with analysts, CEO Sundar Pichai said: “We also offer the industry’s widest range of TPUs [tensor processing units] and GPUs [graphics processing units], along with storage and software built on top. That’s why nearly all gen-AI unicorns use Google Cloud.”
Indeed, Google Cloud’s AI unicorn customer list is impressive, encompassing the cream of the crop in AI talent today:
Safe Superintelligence (co-founded by Ilya Sutskever, an OpenAI co-founder and former Google Brain researcher)
Physical Intelligence (founded by a cohort that includes former Google DeepMind researchers)
Anthropic
Thinking Machines Lab (founded by Mira Murati, former chief technology officer of OpenAI)
World Labs (founded by Fei-Fei Li, a Stanford professor known as “the godmother of AI”)
OpenAI, per a recent Google Cloud deal announced in June.
Image source: Getty Images.
This isn’t a comprehensive list, and Google also has big enterprise customers, including Apple. It’s also encouraging that two of the biggest AI model builders, OpenAI and Anthropic, still choose to run workloads on Google Cloud despite their primary relationships being with other cloud providers and major investors Microsoft and Amazon, respectively.
Why has Google become such a destination for AI start-ups? While that discussion would be long and highly technical, the attraction appears to be based on a combination of factors. First, Google was the first cloud company to begin designing its own AI chips, or “tensor processing units,” back in 2014, in order to power its artificial intelligence research experiments more cost-effectively.
On that subject, Google is the tech giant that has been studying AI seriously for the longest time. Although OpenAI was the first to unveil ChatGPT and assumed the lead in AI chatbots, before that, Google had been the monopolistic center of AI research. Google researchers invented “transformers” technology, the main innovation that catapulted AI technology to the next level over the past eight years or so.
It appears that Google’s legacy position at the forefront of AI research — even though it was initially caught off-guard by ChatGPT in late 2022 — has informed its knowledge of AI infrastructure, paving the way for Google Cloud’s recent success.
Over the course of a year, Google Cloud’s operating profit rose 141%, going from 4.3% of total operating income to 9.1%. Given that Google is accelerating investments and appears to have an accelerating cloud backlog, look for that percentage of profits to increase quickly.
Over time, if Search growth slows or even declines, Google’s own AI service based on its Gemini large language model (LLM) could pick up the slack. But even if that doesn’t happen, it appears there’s a good chance that the next big AI breakout could be one of Google Cloud’s AI unicorn customers. That would lead to growth in Google Cloud profits, offsetting a slowing or decline in Search.
And if Alphabet is able to ward off the threat to Search, the stock will look like one of the biggest bargains on Wall Street, with its cloud business playing a huge part.
Before you buy stock in Alphabet, consider this:
The Motley Fool Stock Advisor analyst team just identified what they believe are the 10 best stocks for investors to buy now… and Alphabet wasn’t one of them. The 10 stocks that made the cut could produce monster returns in the coming years.
Consider when Netflix made this list on December 17, 2004… if you invested $1,000 at the time of our recommendation, you’d have $624,823!* Or when Nvidia made this list on April 15, 2005… if you invested $1,000 at the time of our recommendation, you’d have $1,064,820!*
Now, it’s worth noting Stock Advisor’s total average return is 1,019% — a market-crushing outperformance compared to 178% for the S&P 500. Don’t miss out on the latest top 10 list, available when you join Stock Advisor.
Billy Duberstein has positions in Alphabet, Amazon, Apple, and Microsoft. The Motley Fool has positions in and recommends Alphabet, Amazon, Apple, and Microsoft. 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.
