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Berkshire Hathaway's Top AI Holding Is Poised to Outperform
Key Points
Warren Buffett’s decision to buy Alphabet proved that his circle of competence was still expanding.
Shares of this leading artificial intelligence stock still trade at less than 19 times forward earnings.
Google Cloud’s surging revenue growth and huge backlog clearly indicate robust AI-related demand.
Even in his final years running Berkshire Hathaway, Warren Buffett continued to show he could expand his circle of competence. For the famed investor, the learning process never stopped.
This is precisely what he did when he initiated the buying of Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG) in Berkshire Hathaway's portfolio in the third quarter of last year, a move that current CEO Greg Abel followed up with additional purchases. Between the Class A and Class C shares, the artificial intelligence (AI) hyperscaler represents the conglomerate's fourth-largest position.
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Berkshire Hathaway's top AI holding, Alphabet, is poised to outperform the market. Here's why.
Image source: The Motley Fool.
The low valuation reflects uncertainty
The market might be starting to worry about AI spending. Alphabet's capital expenditures (capex) will total roughly $200 billion in 2026. Next year, management projects it will rise substantially. No one could have predicted five years ago that the capital-light internet giant would embark on a major spending spree.
Free cash flow is negative, coming in at $9.1 billion in the red during the third quarter. Alphabet has started to fund its AI aspirations with external capital. Long-term debt rose 169% from the end of last year to $125.1 billion.
The AI stock, which has soared 124% in the past 36 months (as of Nov. 4), now trades at 28% below its peak. Shares dipped following the announcement of Q3 financial results, as investors digested a miss on both the top and bottom lines, with Google Search sales slowing to 12%.
This exact setup plays into the hands of long-term investors who look at the next five years. It's impossible not to get interested in the current valuation. Alphabet shares trade at a forward price-to-earnings ratio of 18.5. There's a lot of uncertainty surrounding AI. But this is a compelling entry point for one of the world's most outstanding businesses.
AI is the growth engine
According to sell-side analysts' consensus estimates, Alphabet will grow its operating income at a compound annual rate of 28.1% from 2025 to 2028. For a company of this scale, that growth rate is impressive. Revenue surged 25% year over year in the most recent quarter.
Alphabet's leadership position in AI is demonstrated by its Google Cloud segment, which posted a robust 103% Q3 sales gain. That continues a streak of accelerating growth, indicating how much demand there is from customers for AI capabilities. The backlog sits at $561 billion.
Google Cloud benefits from the AI boom by being able to sell specific software and hardware to enterprise clients. Additionally, Alphabet's full suite of products and services also improves with the integration of AI.
While the next few years are impossible to forecast and introduce heightened uncertainty, this company is in a favorable position as it rides the AI wave. The stock can be a big winner.
Neil Patel has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet and Berkshire Hathaway. The Motley Fool has a disclosure policy.