On November 30, 2022, ChatGPT took the world by storm.
Built by San Francisco-based OpenAI, a Microsoft (NASDAQ:MSFT)-backed startup, ChatGPT has attracted Internet users looking for straight answers to their questions — rather than a series of suggested links. It’s delighted students, too, who’ve used the new AI chatbot to turn a one-line prompt into an original 2,500-word term paper. And… it’s lit a fire under Microsoft rival Alphabet (NASDAQ:GOOG), which is now under pressure to come up with an alternative product or risk becoming irrelevant.
On Wednesday, Google announced version 1.0 of its response, a chatbot of its own named “Bard.” The initial demo didn’t go well, however, with Bard responding to an inquiry by (wrongly) asserting that the James Webb Space Telescope was the first telescope to photograph a planet outside of our solar system (In fact, a Chilean telescope was first).
More than just an embarrassment, that mistake seems to have sparked a selloff in Alphabet stock, as investors absorbed the implication that Alphabet — believed to be a leader in AI — is subject to the same limitations that others have pointed out in ChatGPT.
Can Alphabet recover from its fumble, though? This is the question that Goldman Sachs analyst Eric Sheridan tackled in a wide-ranging note covering Alphabet’s various artificial intelligence and machine learning initiatives.
The “AI arms race,” argues Sheridan, will be “the dominant investing theme” among tech stocks for at least the next few months as Microsoft and Alphabet — and Amazon (NASDAQ:AMZN), Meta (NASDAQ:FB), Apple (NASDAQ:AAPL), Baidu (NASDAQ:BIDU), and Alibaba (NYSE:BABA), too — all vie for supremacy in this space, and throw “tens of billions of dollars” into the effort to build increasingly better AI mousetraps. Which company will emerge victorious — Sheridan doesn’t even try to guess, admitting it’s simply too “difficult to forecast.” But one thing the analyst does think certain:
Whoever wins, and regardless of whether the winner is single, or whether multiple platforms end up with a piece of the AI market, the cost of this effort will take a toll on Alphabet in the short term.
Proceeding from an estimate that Alphabet has already spent anywhere from $27 billion to $137 billion on AI research to date, and guessing at what it might have to spend to keep up with the AI arms race in future years, Sheridan warns that investors can expect Alphabet’s gross profit margin to shrink by somewhere between 60 basis points and 230 basis points over the next couple years.
True, Alphabet regularly rakes in gross profit margins of 55% and up today, so even a full two percentage-point decline will hardly kill the business. But it might hurt. Additionally, there’s the risk to market share — and the revenues those gross margins are applied to. As Microsoft has observed, it’s currently really a runner-up in internet search, so all Microsoft really has to do with its Bing-ChatGPT partnership is add a few customers and steal a few points of market share from Google — and it will come out of this a winner.
As the dominant player in search and search advertising, however, Alphabet must run simply to stay in place. This makes AI less of an opportunity for Alphabet, and more of a costly necessity. For this reason, it’s curious that after outlining all the risks,
Overall, however, Sheridan comes to the conclusion that Alphabet stock is a “buy” and worth 31% more than it costs today — $124.60 a share. (See Sheridan’s track record, click here)
Alphabet is that rare beast – a stock with plenty of coverage where everyone is in agreement. It has garnered 32 analyst reviews over the past 3 months – all Buys – naturally making the consensus view here a Strong Buy. The average target currently stands at $129.34, implying the shares will deliver returns of ~37% over the one-year timeframe. (See GOOGL stock forecast)
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Disclaimer: The opinions expressed in this article are solely those of the featured analysts. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.