Key Points
Alphabet started recording TPU sales in the second quarter.
This business may eventually contribute to top-line growth.
Alphabet looks like a no-brainer buy right now.
Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) posted blowout second-quarter results on July 22. Many of the headlines focused on the company's cloud business, and with good reason. Google Cloud's sales were $24.8 billion, 82% higher than the year-ago period. Sales growth in this business accelerated significantly from the 63% Alphabet recorded in the previous quarter, and the tech leader also ended the period with a $514 billion cloud backlog.
Alphabet could continue to see its cloud business perform well in the next few years, and the company recently began recording a new revenue stream that may become a meaningful growth driver over time, while also affecting other companies such as Broadcom (NASDAQ: AVGO) and Nvidia (NASDAQ: NVDA). Here's what investors need to know.
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Multiple growth pathways
Alphabet has been relying on its TPUs (Tensor Processing Units) -- custom artificial intelligence (AI) chips designed to handle specific workloads -- in its cloud computing segment for some time. The company still orders chips from external suppliers. But TPUs have become increasingly important for Alphabet. And earlier this year, the company's CEO, Sundar Pichai, said it would start selling TPUs to select outside customers, given the soaring demand for these products.
During Alphabet's second-quarter earnings conference call, management announced that the company had started to realize revenue from these sales. They are likely a minuscule part of the company's total revenue for now, but if demand for these chips remains high enough, Alphabet could be looking at another source of top-line growth. It would also put the company in direct competition with Nvidia. Custom chips have some advantages. They are cheaper than Nvidia's GPUs (Graphics Processing Units) and highly effective at handling the workloads for which they were designed. They can also help companies reduce their exposure to Nvidia, a meaningful perk even beyond the cost savings.
Now, where does Broadcom fit into all this? It has worked with Alphabet to design TPUs, and the two companies have a long-term deal extending through 2031. So, if Alphabet's TPU sales grow at a good clip, that will be great for Broadcom's business as well. Now, does any of this make Alphabet stock a buy? The company's TPU business may become an important growth driver. Only time will tell. But for now, there is still significant uncertainty there. Meanwhile, there are much better reasons to consider the stock, and the company's high-flying Cloud business is just one of them.
Alphabet also dominates the digital advertising market, thanks to its runaway lead in internet search and solid position in streaming. These are aspects of the business that AI has improved, and considering these industries boast attractive long-term prospects, Alphabet may ride these tailwinds for a while. Even with the significant capex that drove its free cash flow into negative territory in the second quarter, the tech giant's financial results and opportunities more than justify the investments. Alphabet is well-positioned to outperform the broader market in the long run.
Prosper Junior Bakiny has positions in Alphabet and Nvidia. The Motley Fool has positions in and recommends Alphabet, Broadcom, and Nvidia. The Motley Fool has a disclosure policy.