Those who invested in Nvidia (NASDAQ: NVDA) a few years ago are sitting pretty right now. The tech giant has seen its shares skyrocket, even more so than its otherwise high-performing “Magnificent Seven” peers, partly thanks to its artificial intelligence (AI) system sales.
However, as is often the case with stocks that crush the market, some investors are now worried about valuation. With a forward price-to-earnings ratio of about 35 — where the average for the S&P 500 is 20 — Nvidia’s shares don’t exactly look cheap.
The premium might be justified if the chipmaker continues delivering the kinds of results it has lately, but for investors who want a cheaper Magnificent Seven stock that can also allow them to profit from the AI boom, let’s consider why Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) is a solid option.
AI will be a significant growth driver
The rise of generative AI leader ChatGPT initially spooked Alphabet’s shareholders. Some saw the technology as being a Google killer. Alphabet generates the bulk of its revenue from ads on Google, so if it loses significant market share in online search, its financial results will worsen considerably.
This is a reasonable fear, but Alphabet wasn’t worried. The company has been implementing AI within its business for years, including in updates to its Google algorithms.
Alphabet quickly released its ChatGPT competitor, Bard, which has since been rebranded as Gemini. Alphabet’s Gemini goes beyond text generation into videos, images, and computer coding. The company is still improving Gemini and other AI models it has developed while integrating various AI features throughout its business to make it more efficient and productive, from online search to advertising services.
The result should be stronger top-line growth and operating margins. Alphabet also offers various AI services through its cloud business, Google Cloud. As company CEO Sundar Pichai said during Alphabet’s first-quarter earnings conference call:
Our differentiation in Cloud begins with our AI Hypercomputer, which provides efficient and cost-effective infrastructure to train and serve models. Today, more than 60% of funded gen AI start-ups and nearly 90% of gen AI unicorns are Google Cloud customers.
The race to develop more sophisticated generative AI platforms should be a growth driver for Alphabet.
More reasons to buy
Alphabet’s forward price-to-earning (P/E) ratio is just under 22, which is still higher than the S&P 500’s average but much lower than Nvidia’s. Perhaps Alphabet’s comparatively low P/E reflects the fact that it isn’t growing as fast. Still, the business is solid and continues to deliver strong financial results. In the first quarter, the company’s total revenue of $80.5 billion increased by a healthy 15.4% year over year.
Alphabet’s operating margin landed at 32%, higher than the 25% generated in the prior-year quarter, while its net earnings per share of $1.89 was 61.5% higher. Alphabet has other growth drivers beyond AI, including in streaming with YouTube. The website is the leader in streaming in terms of watch time, though it isn’t exactly comparable to platforms like Netflix that offer movies and TV shows.
Still, the increase in viewing time is a magnet for advertisers who will continue to flock to the platform so long as YouTube remains a leader, something that shouldn’t change anytime soon. YouTube benefits from the network effect: The more content creators on the platform, the more it becomes attractive to viewers, and vice versa. Alphabet should still have a long runway for growth in this area.
Lastly, the company recently announced it was initiating a quarterly dividend per share of $0.20. And for what it’s worth, the tech giant will also repurchase $70 billion worth of its shares.
Will Alphabet become a great dividend stock in time? It’s too early to tell. However, given the company’s solid underlying business, strong cash flow generation, and multiple growth avenues, it has the tools to be an excellent dividend payer. Incidentally, these qualities also make the stock a great buy.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Prosper Junior Bakiny has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet, Netflix, and Nvidia. The Motley Fool has a disclosure policy.
Think Nvidia Is Overvalued? Buy This “Magnificent Seven” Stock Instead was originally published by The Motley Fool
