Explosive Google Cloud Growth Mispriced by Wall Street

While Wall Street reacted positively to Alphabet’s (GOOGL) third-quarter results, I believe the stock remains undervalued, which presents an attractive opportunity today. Alphabet’s core businesses, such as Google Search and YouTube, remained robust and showed impressive growth in the third quarter. The real highlight of the report, however, was Google Cloud, which not only registered a notable acceleration in revenue growth, but also showed a significant increase in operating income. Still, Alphabet’s valuation doesn’t seem to fully reflect its continued momentum. For this reason, I remain invested in Alphabet, with confidence in the stock’s potential for upside.

Alphabet’s key revenue segments, Google Search and YouTube, once again delivered solid numbers in the third quarter, reinforcing the company’s position as a leader in digital advertising and search. While I hear concerns from investors and analysts about Alphabet’s lagging position in large language model (LLM) search, the company continues to generate more and more advertising revenue.

Specifically, Google Search saw a 12% year-over-year revenue increase, with management citing growing user engagement fueled by recent AI tools like AI Overviews and Circle to Search. AI Overviews has now been rolled out to more than a billion users worldwide, enabling more complex searches and expanding the way people interact with Search. Circle to Search, another AI feature that lets users draw a circle around an object in an image to instantly search for similar items, is now active on more than 150 million Android devices.

The Circle to Search feature is quite popular. Management reported that a third of those who tried it now use it weekly, which translates into a strong indication of its value.

Meanwhile, YouTube recorded 12% growth in ad revenue, driven by branded and direct response ads. The platform’s progress in creating a more TV-like experience, including features like Multiview, has certainly increased its appeal, especially in the living room. Shorts are also doing very well and monetization is strengthening again this quarter. It will be interesting to see how quickly it overtakes in-stream video, especially in the US and other markets with high ad revenues. Remarkably, 70% of the channels that upload to YouTube every month post Shorts, allowing Alphabet to rake in even more advertising money.

Besides Alphabet’s core segments performing well, the real highlight of the third quarter was Google Cloud, a key driver of my positive view on the stock. The segment saw its revenue grow 35% year-over-year, an acceleration from the previous quarter’s 29% growth and well above last year’s 22%. This acceleration is made possible by Alphabet’s expanding AI infrastructure, including its Gemini models, which power multimodal AI and real-time analytics solutions.

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While these tools may not yet have broad resonance with mainstream consumers, which could explain why some see Alphabet as lagging behind, they are quickly being embraced by large commercial customers. Notable examples from the third quarter include Snap (SNAP) and Hiscox (GB:HXS). In the case of Hiscox, the company was able to reduce the time needed to generate complex insurance quotes from days to just minutes. I think this shows Alphabet’s real potential to increase revenue by creating value for its customers. As AI tools help companies operate more efficiently and save costs, more customers will likely be willing to pay for the benefits they see.

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But more importantly, Google Cloud is gradually growing as a profit generator for the entire company. Operating income rose to $1.9 billion from just $266 million a year ago. This dramatic increase in profitability reflects Alphabet’s success in achieving economies of scale, with operating margin in the Cloud segment increasing to 17% from 3.2% last year.

Despite Alphabet’s impressive Q3 results, Wall Street appears to be undervaluing the stock. Alphabet in particular is trading at just over 21 times the 2024 consensus estimate of $7.99 per share, a fairly low multiple considering accelerating revenue and profit growth, especially in the cloud. Looking further ahead to 2025, Alphabet’s earnings numbers drop to about 19 times expected earnings. I think this makes for a fairly attractive valuation compared to the broader S&P 500 (SPX), where many companies trade at much higher prices, with significantly weaker growth prospects. Historically, there have been few opportunities to buy Alphabet at a price-to-earnings ratio of less than 20, and each time, in hindsight, it has proven to be very rewarding.

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Looking at Wall Street’s view on GOOGL stock, Alphabet has a Strong Buy consensus rating based on 26 Buys and six Holds assigned in the last three months. At $207.43, Alphabet’s average price target suggests 21.1% upside potential.

If you’re still deciding which analyst to trust when trading GOOGL stock, consider Mark Kelley of Stifel Nicolaus. He is the most profitable analyst covering the stock (over a one-year period), with an average return of 27.87% per rating and an 85% success rate.

In summary, Alphabet’s third quarter results show excellent numbers across the board. All core segments, including Google Search, YouTube and especially Google Cloud, achieved excellent revenue and profit figures. For this reason, I believe that Alphabet shares are undervalued at their current levels. With revenue and earnings growth set to continue at double digits next year and beyond, Alphabet shares are still trading at a discount even after recent earnings gains. That’s why I remain invested in Alphabet, now my second-largest personal holding.

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