'Fast Money' traders talk Alphabet's record trading day

Key Concepts

• AI Trade: Refers to the market performance and investor sentiment surrounding companies heavily involved in Artificial Intelligence development and deployment.
• Mag-7: A colloquial term for the seven largest technology companies in the S&P 500 index, often considered market leaders.
• Rotation: A shift in investor capital from one sector or asset class to another, often driven by changing market conditions or sentiment.
• Bard: Google's initial conversational AI chatbot, which experienced a poorly received launch.
• ChatGPT: OpenAI's popular conversational AI model, which set a benchmark for AI chatbot performance.
• Gemini: Google's advanced AI model, which has seen multiple iterations and improvements.
• DOJ Settlement: A legal agreement between the U.S. Department of Justice and Google, which clarified Google's position in certain market segments.
• CapEx Spend: Capital expenditures, referring to the money a company spends to acquire or upgrade physical assets such as property, industrial buildings, or equipment.
• Net Cash: A company's cash and cash equivalents minus its total liabilities, indicating a strong financial position.
• Forward PE Ratio: The price-to-earnings ratio calculated using expected future earnings, used to assess a stock's valuation.
• Google Cloud: Google's cloud computing service, which is a smaller but growing segment of the company's business.
• Sum of the Parts Valuation: A valuation method that assesses a company's total worth by valuing each of its business segments individually and then summing them up.
• YouTube: Google's video-sharing platform, considered a valuable asset with significant monetization potential.
• Waymo: Google's self-driving car company.
• Other Bets: A segment of Alphabet (Google's parent company) that includes various experimental and long-term projects.
• Monetization of AI: The process of generating revenue from AI technologies and applications.
• Upside Calls: A type of financial option that allows the holder to profit if the underlying asset's price increases. Selling upside calls can be a strategy to generate income or hedge against potential price declines.

Alphabet's Rebound and the AI Trade

The discussion centers on Alphabet's recent stock performance, which has seen a significant rebound (up 13% this month) while other AI darlings like Oracle have faltered (off nearly 24%). This raises questions about whether Alphabet's recovery is a positive or negative indicator for the broader AI trade and if a rotation is occurring within the market.

Key Points on Alphabet's Performance:

• Rotation in the Market: Dan suggests a definite rotation is happening, with a handful of "Mag-7" companies underperforming their peers and the S&P 500.
• Overcoming a Bad Rollout: Alphabet has made considerable progress since the "really bad rollout" of Bard, which was a significant misstep following ChatGPT's success.
• Distribution Advantage: Alphabet possesses a significant advantage with 6 or 7 platforms boasting over 2 billion users, allowing for widespread integration of AI technology.
• Potential Impact on Search Revenue: The emergence of AI overlays and "AI mode" could potentially dent search revenue, a key component of the bear case against Alphabet.
• Valuation Concerns: Despite the strong recent performance, the stock is trading at approximately 27-28 times forward earnings. The growth rate is not accelerating, leading to questions about whether consensus estimates are too low or if there's further room for growth.
• Forward PE Closer to 30: The recent run has pushed the forward PE ratio closer to 30, making the stock appear more expensive.
• Google Cloud Growth: While smaller than search, Google Cloud is experiencing significant growth (50%). However, its margins are projected to decrease by 2% next year, which is seen as a negative trend by some.
• Earnings Growth Expectations: Current expectations for earnings growth are in the high single digits, suggesting a need for meaningful upgrades to meet higher valuations, especially with a weakening margin environment.
• Unexpected Recovery: The stock's extraordinary run was unexpected, especially given prior concerns about the demise of core search.
• Gemini Improvements and DOJ Settlement: The multiple iterations and improvements of Gemini, coupled with the DOJ settlement that secured Google's market turf, have contributed to the positive sentiment.
• Oversold and Underappreciated: The stock was previously oversold and underappreciated, with the analyst community seemingly caught off guard by the Gemini updates.
• Positive for the Broader Market: The strong performance of Alphabet and Broadcom outside of the core Mag-7 in the last 6-8 weeks is seen as a positive for the market heading into year-end.
• Semiconductor Strength: The semiconductor sector (SOX) has also shown resilience, bouncing back significantly from recent lows, indicating that investors are still engaged in this trade.

Specific Details and Figures:

• Alphabet up 13% this month.
• Oracle off nearly 24% this month.
• Google Cloud growth: 50%.
• Projected margin check down for Google Cloud next year: 2%.
• Expected earnings growth for Alphabet: high single digits.
• Forward PE ratio: 27-28 times, potentially closer to 30 after the recent run.
• Platforms with over 2 billion users: 6 or 7.
• SOX (Semiconductor Index) up 9% from intraday low on Friday.

Search Fears and CapEx

The discussion addresses the fears surrounding Google's core search business and its significant capital expenditure (CapEx) spend.

Key Points:

• Overblown Fears: Fears about the demise of search are considered overblown at the moment, though its future evolution remains uncertain.
• CapEx Spend and Balance Sheet: While companies are in a CapEx spending phase, Google's balance sheet remains strong with net cash, indicating it's not a drain on the company.
• Funding CapEx: Debt financing is suggested as a more sensible approach for funding CapEx for Google.
• YouTube's Undervalued Potential: The "sum of the parts" valuation for YouTube is not receiving enough attention, despite its significant value.
• Other Alphabet Assets: Waymo and "Other Bets" are mentioned as part of Alphabet's portfolio, with "Other Bets" being a net negative.
• Monetization of AI: The full potential of AI monetization for Google has not yet been realized, though some impact has been seen in search performance.
• Antitrust Remedy: The resolution of the first part of the antitrust concerns was more favorable than anticipated.

Valuation and Future Outlook

The conversation concludes with a debate on whether Alphabet is currently overvalued and the potential for further upside.

Key Points:

• Is it Overvalued? The question of whether Alphabet is overvalued is posed, with the immediate answer being "No."
• Selling Upside Calls: Despite the positive outlook, one speaker expresses an intention to sell upside calls, suggesting a belief that the stock has run too far, too fast, and might be due for a pullback or consolidation. This indicates a strategy to profit from potential price stagnation or a slight decline.

Conclusion and Takeaways

Alphabet's recent surge in stock price, driven by improvements in its AI offerings like Gemini and a favorable DOJ settlement, has countered earlier fears about its core search business. While the company benefits from a strong distribution network and a healthy balance sheet, concerns remain regarding its valuation (forward PE approaching 30) and the potential impact of AI on search revenue. The market is experiencing a rotation, with tech giants like Alphabet showing renewed strength, which is positive for the broader market sentiment. However, the rapid ascent of Alphabet's stock has led some to consider strategies like selling upside calls, indicating a cautious optimism and a recognition of potential short-term pullbacks. The full monetization potential of AI for Google is still largely untapped, and valuable assets like YouTube are considered undervalued.