Valuentum Exclusive Analysis for the Discerning Investor

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By Brian Nelson, CFA

The race to capture the next-generation opportunity in web search technology is fast-developing. OpenAI took the world by storm when it released ChatGPT in December 2022, sparking the proliferation of ChatGPT rivals, the list of a dozen of which can be found here. In this article, we provide a timeline of our take as it relates to large language models with respect to web search technology, and why we view playing both Alphabet (GOOG) (GOOGL) and Microsoft (MSFT) as it relates to search and AI technology may be the best way to approach new developments in this area, which are still in their very early stages.

It’s very likely that, if Google search is eventually disrupted, much of the disruption would come from Microsoft given its deep pockets and existing search engine Bing. We continue to include both Alphabet and Microsoft in the Best Ideas Newsletter portfolio as a hedge in this regard. If any share shifts do occur away from Google search, they’ll likely accrue to Microsoft, and with both Alphabet and Microsoft large components of big cap tech and the stylistic area of large cap growth, considering the Schwab Large Cap Growth ETF (SCHG) may also be worthwhile. We like both Alphabet and Microsoft and view any share shifts as net neutral to our exposure in the Best Ideas Newsletter portfolio.

December 5, 2022 - Maintaining Our Fair Value Estimates Across Ad-Driven Social Media Equities In Light of Long Term AI-Driven Chatbot Threats: Though there are skeptics out there on this current AI iteration and perhaps some may have already found some bugs (it only has data going up to late last year), others are calling it "scary-good, crazy-fun," and Mashable noted that "OpenAI is a huge step toward a usable answer engine." Whether or not the current iteration of this AI-driven chatbot is ready for the real world, however, is not necessarily the question when it comes to investors. The reality is that ChatGPT showed us something, and we think it has shown a lot of people, that even with its flaws, AI, in the long run, is going to change a lot of industries, and perhaps no other feature may be more comparable to AI-driven chatbots than Alphabet's search engine, Google. Meta Platforms (META) experienced a major disruption when TikTok emerged, and ChatGPT or something similar to it, if or when it establishes a revenue model, may be a huge disruptor to Google. Though it's not something that is going to happen overnight, of course, we think long-term investors of Alphabet should take note. We're not going to overreact, however. It has taken nearly two decades for Alphabet to establish its search dominance, and one tool in its early innings may be something to keep one's eyes on, but not panic over. We also can't be completely sure what's included in Alphabet's 'Other Bets' segment, and it's possible Alphabet may have something even better in that area, whether it is in AI or other.

January 11, 2023 -- We’re Glad Microsoft Sees Promise in ChatGPT: Not having to worry about an upstart taking ChatGPT to the finish line is a big relief for the newsletter portfolios. Having already invested $1 billion in ChatGPT’s owner OpenAI in 2019, Microsoft Corp. may invest as much as $10 billion more in the artificial intelligence (AI) chatbot. Reports indicate that Microsoft would own a 49% stake in OpenAI, while getting a 75% share of OpenAI’s earnings. The greater control over ChatGPT, of which we brought to readers attention in our December 5 note, “Maintaining Our Fair Value Estimates Across Ad-Driven Social Media Equities In Light of Long Term AI-Driven Chatbot Threats (excerpt above),” will likely augment Microsoft’s search technology and its web browser Bing, which is practically insignificant when compared to the dominance of search giant Alphabet’s Google. We include both Microsoft and Alphabet in the simulated Best Ideas Newsletter, so while the news may be incrementally negative for Alphabet, it is equally incrementally positive to Microsoft, and therefore largely net neutral on the simulated Best Ideas Newsletter portfolio...We’re going to be hearing a lot more about artificial intelligence chatbot technologies in the coming years, and our initial interaction with ChatGPT a month ago indicates to us that it will be a gamechanger for a lot of industries. Microsoft’s continued backing in OpenAI, the owner of ChatGPT, will likely accelerate the technology’s development, and we expect it to eventually augment Microsoft’s own search technology and ad-driven revenue opportunities. Alphabet may have a few AI tricks up its own sleeve in its ‘Other Bets’ segment, so we’re not ruling out a highly competitive environment in this area in the coming years. We like that we include both Microsoft and Alphabet in the simulated newsletter portfolios and that we’re not forced to make a decision on whether a new upstart is worthy of inclusion. Our fair value estimate for both Microsoft and Alphabet remain unchanged at this time.

January 24, 2023 -- Microsoft Is Betting Big on Artificial Intelligence (AI); Fiscal Q2 Shows Meager Revenue Growth, Weaker Cash Flow Generation: “The age of AI is upon us and Microsoft is powering it. We are witnessing non-linear improvements in capability of foundation models, which we are making available as platforms. And as customers select their cloud providers and invest in new workloads, we are well positioned to capture that opportunity as a leader in AI. We have the most powerful AI supercomputing infrastructure in the cloud. It’s being used by customers and partners like OpenAI to train state-of-the-art models and services, including ChatGPT.” – Microsoft CEO Satya Nadella (January 24, 2023)

July 25, 2023 -- First Read: Microsoft, Alphabet Cash Components Wonderful in Calendar Q2 2023: Microsoft’s quarterly results showed revenue advancing 8% (up 10% in constant currency), while operating income leapt 18% (up 21% in constant currency). Microsoft Cloud revenue advanced 23% on a year-over-year basis, while Office Commercial products and Office 365 Commercial jumped at a mid-to-high teens percentage pace. 'Azure and other cloud services' leapt 27% on a constant currency basis in the quarter. Alphabet’s quarterly results showed revenue on a constant currency basis of 9% in the quarter, while operating income jumped 12.3%. Google Search and other showed a 4.7% year-over-year revenue advance in the quarter. Artificial intelligence remains a huge catalyst for both companies, and we look to a very bright next couple of years in this area. We remain bullish on both and expect continued strength for some time to come.

January 30, 2024 -- Alphabet, Microsoft Remain Cash-Rich, Secular Growth Powerhouses: Commentary from both Alphabet and Microsoft was positive on AI, with Alphabet noting that its divisions are benefiting from its AI investments, with CEO Sundar Pichai noting that “the best is yet to come.” Microsoft’s commentary was perhaps even more positive, with CEO Satya Nadella saying that it has “moved from talking about AI to applying AI at scale.” As noted before, there are concerns growing about the potential for AI to disrupt Google Search in the long run, but if investors hold both Alphabet and Microsoft, as in the Best Ideas Newsletter portfolio, it’s likely that any share shifts in search advertising due to AI may accrue in part to Microsoft Bing. Both Alphabet and Microsoft remain net-cash-rich, free-cash-flow generating, secular growth powerhouses, and we remain fans.

Concluding Thoughts

The number of large language models coming to the fore has increased considerably since the widespread rollout of ChatGPT in late 2022. At this point in the development cycle, it’s unknowable how these models may transform our lives as we currently know it, and how they may disrupt Alphabet’s search business along the way. Alphabet’s Google has complex algorithms backing it and allows users to verify facts with search results, perhaps the key features that would keep Google on top when it comes to search advertising. As we’ve reiterated several times during the past 12-18 months, we continue to like both Alphabet and Microsoft, not only as net-cash-rich free-cash-flow generating powerhouses, but also as hedges to play how AI may change the search advertising landscape. 

NOW READ: Alphabet, Microsoft Remain Cash-Rich, Secular Growth Powerhouses

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Tickerized for GOOG, GOOGL, META, MSFT, SCHG, XLK, SOUN, BBAI, AI.

Brian Nelson owns shares in SPY, SCHG, QQQ, DIA, VOT, RSP, and IWM. Valuentum owns SPY, SCHG, QQQ, VOO, and DIA. Brian Nelson's household owns shares in HON, DIS, HAS, NKE, DIA, RSP, SCHG, QQQ, QQQM, and VOO. Some of the other securities written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies. 

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