Google Is Just Fine in Spite of Microsoft's ChatGPT Bet on AI Internet Search

There has been no shortage of media hoopla surrounding generative AI this year. Alphabet's (NASDAQ: GOOGL)(NASDAQ: GOOG) long dominance of internet search is seemingly being challenged by Microsoft's (NASDAQ: MSFT) investment in ChatGPT and the subsequent infusion of its Bing search engine with the conversational AI service. Google is toast, right?

Though ChatGPT and the swarm of generative AI services it helped spawn have been likened to an Apple iPhone moment (basically, a transformation of the tech status quo), Google is hardly toothless. Its first quarter 2023 earnings show some proof of that.

A better-than-expected start to 2023 for Alphabet

First, the high-level numbers. Alphabet's financials exceeded expectations, with revenue and earnings per share (EPS) both beating analyst forecasts.

Metric

Q1 2022

Q1 2023

YOY % Increase (Decrease)

Revenue

$68 billion

$69.8 billion

3%

Earnings per share

$1.23

$1.17

(5%)

Free cash flow

$15.3 billion

$17.2 billion

12%

Data source: Alphabet. YOY = year-over-year.

Google's revenue continues to be dominated by advertising (78% of the total last quarter), so global economic weakness is hurting the top line. When the economy heads south, marketing budgets are often the first to get slashed. There's more to the sluggish revenue line item, though. As has been the case for over a year now, a record run-up in the U.S. dollar (driven by Federal Reserve interest rate hikes) clobbered the value of international sales at Google. Revenue excluding exchange rate impacts would have been up 6%, versus the 3% growth reported. Those same currency headwinds had an even greater impact on EPS, which pushed the metric into a slight year-over-year decline.

Nevertheless, Google did benefit from a sharpened focus on cost controls, so free cash flow rose year over year. The company returned most of that $17.2 billion in free cash flow to shareholders via ongoing stock repurchases. Management repurchased $14.6 billion worth of stock last quarter and approved a new repurchase plan of up to $70 billion to be executed over time (worth 5.2% of the current market cap, if you're looking for an equivalent to dividend yield).

Google reminds us AI isn't new

OK, back to all the fuss over AI. Alphabet CEO Sundar Pichai and the top team didn't miss an opportunity to pump its own AI chops during the conference call. Pichai reminded everyone that Google has been a pioneer in AI for many years, including in Google Search, where it continuously added intelligent tools like Google Lens (search with camera), Google Translate, and behind-the-scenes AI-powered advertising tools for businesses.

Sure, Microsoft Bing powered by ChatGPT has picked up some users here and there, especially in the high-tech community where experimenting with new tools is the norm. But Google was quick with a response: Its own conversational AI search called Bard (I'm still not loving the name) and generative AI tools like those aimed at supercharging software developer productivity (more on that in a moment).

For the rank-and-file consumer, though, it appears Google is still synonymous with the internet itself. In fact, just to prove Google is just fine, Google Search-specific revenue actually jumped nearly 2% higher year over year, offsetting some weakness in ads at YouTube and Google Network partner ads.

Turns out the biggest existential threat to Google Search wasn't Microsoft Bing-plus-ChatGPT conversationality, but rather, simply a downturn in the digital advertising market driven by a weakening global economy. Go figure.

Google Cloud, also infused with AI, takes the spotlight

Just as Microsoft is putting generative AI to work in its software suite beyond internet search, so is Google. One highlight during the earnings call was Google Bard as part of the fast-growing Google Cloud segment, powering companies from self-driving car start-ups to media professionals using Google Cloud generative AI services to speed up creative work. Pichai said Google Cloud deals with large customers worth over $250 million grew 300% year over year last quarter.

At $7.45 billion in revenue in Q1 (a nearly $30 billion annualized run rate), Google Cloud still has some catching up to do with Microsoft Azure and cloud industry pioneer Amazon (NASDAQ: AMZN) AWS. Amazon CEO Andy Jassy pointed out in his recent annual shareholder letter that AWS exited 2022 at a more than $80 billion annualized revenue run rate. And Microsoft just reported "Intelligent Cloud" revenue (which includes Azure) of $22.1 billion during the first three months of 2023 alone, up 16% year over year (Azure stand-alone revenue was up 27%).

Google Cloud revenue in Q1 2023 was up 28% year over year, inclusive of currency exchange rate headwinds. And better still, the cloud segment reported an operating profit -- $191 million -- for the first time.

Indeed, Google is going to be more than just fine in this new era of AI. Shares trade for 21 times trailing-12-month EPS, or 22 times trailing-12-month free cash flow, after the Q1 2023 report. I, for one, am still a buyer.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Nicholas Rossolillo and his clients have positions in Alphabet, Amazon.com, and Apple. The Motley Fool has positions in and recommends Alphabet, Amazon.com, Apple, and Microsoft. The Motley Fool has a disclosure policy.