It’s not a leading profit center right now, but give it time. It could become one, helping to further offset any moves by the Justice Department.
There’s no denying that Google is a parent Alphabet (GOOG 1.17%) (GOOGL 1.11%) is facing a troubling legal challenge right now. The Department of Justice (DOJ) has successfully argued that this is a monopoly… in more ways than one.
The company intends to appeal the decision, of course, but in the meantime it is preparing to push back against the DOJ’s recommendations for remedies. Abandoning the Android operating system and/or the Chrome web browser are both possibilities, and Alphabet’s payments to third parties to make Google their preferred search engine may also be coming to an end. We’ll know more in September once the decision-making stage of the process begins.
Here’s the good news: Google is a proven force and has been in similar situations before. So the headlines may make the issue seem like more of a threat than it really is. Even if the company is forced to abandon Chrome or Android, or has to share more data with competitors, everything will be fine.
Indeed, Alphabet is likely to be even stronger for the foreseeable future for reasons that have nothing to do with its web search business. Google’s cloud computing division is an underrated growth engine for three reasons investors may be overlooking.
How Google Cloud is making Alphabet stock a buy
1. Growing market share
Alphabet competes with the likes of Amazon (NASDAQ: MSFT) and Microsoft (NASDAQ: MSFT) on the cloud computing front. Enterprises that prefer not to make large upfront investments in their own cloud infrastructure can simply tap Google (or a competitor) to handle this work remotely.
Google isn’t a big player in cloud computing, mind you. That’s far less than Microsoft’s operations in that market, which is much smaller than Amazon Web Services (AWS). However, numbers from Synergy Research Group show that Google Cloud’s share of the global cloud computing market is actually growing faster than the share of any of its competitors.
Data source: Synergy Research Group. Graphics by author.
Of course, it can sometimes be easier to gain share when you start from a smaller base, while bigger players have a harder time moving the needle that much. In the case of the cloud computing industry, however, greater scale is usually a competitive advantage, so it appears that Google Cloud is simply doing something better than its competitors.
This increasing degree of market share should be maintained for the foreseeable future if the underlying computing architecture is anything to go by.
2. New chips
To date, most cloud computing data centers (including those focused on AI tasks) have relied on processors and chips that worked well enough but were repurposed technologies intended for other purposes. for example, Nvidiais (NASDAQ: NVDA) the earliest AI processors were mostly just repurposed graphics cards that happened to be capable of processing the massive amounts of data required in AI applications.
As the next chapter of the AI revolution unfolds, we need better technology.
That’s where Google’s new Axion chips come into the picture. Based on Arm Holdings‘ (NASDAQ: ARM) architecture, Google’s proprietary Axion processors deliver 30% better performance than similar general-purpose microchips and 50% better performance than mainstream PC processors made by Intel (NASDAQ: INTC) or Advanced Micro Devices. Perhaps most importantly, Google’s Axion-based cloud platforms will legitimately compete with Nvidia’s solutions, which dominate the AI market largely because there hasn’t been a viable alternative.
3. Margin moves
Last but certainly not least, Google Cloud may finally be profitable, but it’s still far from contributing as much to the company’s bottom line as it eventually will.
The graphic below tells the story. Google’s cloud business turned an operating profit for the first time in the first quarter of last year and has steadily increased that net income in line with revenue growth. Of the $10.3 billion in cloud computing revenue last quarter, nearly $1.2 billion of that—roughly 11 percent—was converted into operating income. it’s not bad
Data source: Alphabet. Graphics by author. Revenue and operating income figures are in billions.
But that’s just a fraction of the margins Google Cloud’s biggest competitors are seeing with their cloud businesses. In the first half of this year, AWS boasted an operating profit margin of 36%. Microsoft’s cloud operating revenue was in the order of 45%. If Google Cloud were already so profitable, its second-quarter operating profits would be around $4 billion, not just $1.2 billion.
For perspective, Alphabet’s total operating income last quarter was $27.4 billion.
Connect the dots. Google Cloud has the potential to make a major upside dent in Alphabet’s bottom line, especially given the continued growth of the cloud computing industry. Market research organization Mordor Intelligence believes the global cloud market will expand at an annual rate of over 16% through 2029.
Alphabet stock still has plenty of upside
None of this is to suggest that current and future shareholders should ignore Alphabet’s ongoing legal troubles. Even if all the company’s appeals are successful, regulators are still clearly targeting big tech. The organization will be forced to change at least some aspects of its business sooner or later, and those changes will likely weaken the leverage that Alphabet currently enjoys.
But I’m confident that even if the DOJ’s future actions undermine its business, the company will find a way to win.
Meanwhile, the market is likely underestimating how much profit Google Cloud could potentially add to the bottom line. This could well offset any loss of profit incurred in connection with the DOJ’s moves.
In other words, there are still more reasons to own this stock at its current price than not.
Suzanne Frey, CEO of Alphabet, is a member of The Motley Fool’s board of directors. James Brumley has positions in Alphabet. The Motley Fool has positions in and recommends Advanced Micro Devices, Alphabet, Microsoft and Nvidia. The Motley Fool recommends Intel and recommends the following options: long January 2025 $45 calls on Intel, long January 2026 $395 calls on Microsoft, short August 2024 $35 calls on Intel and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.