Barron's Streetwise - Google Arrives At An A.I. Crossroads

Episode Date: May 24, 2024

Will smarter search make or break Alphabet? A top internet analyst weighs in.  Learn more about your ad choices. Visit megaphone.fm/adchoices

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You don't have to just go to Google anymore. Hello and welcome to the Barron Streetwise podcast. I'm Jack Howe, and the voice you just heard, that's Brent Thill. He's an analyst at Jefferies covering Alphabet and other software and internet giants like Microsoft and Amazon and meta platforms. And he's talking about search, which is dominated by Alphabet's Google, but which faces the most upheaval in decades from artificial intelligence. We'll hear about that and what it means for Alphabet stock. Listening in is our audio producer, Jackson.

Hi, Jackson. Hi, Jack. You've Googled, but have you perplexity-ed? I have not yet perplexity-ed. Let's do some perplexity-ing together. We'll go to perplexity.ai. Give me a product search. What are we looking for? What are you in the market for?

Lime juicer. What's the best lime juicer? It's margarita season. Is there a season? Okay, so what I get for an answer is a write-up. And it has a specific recommendation here. It says the Chef in Fresh Four Citrus Juicer is widely considered the best considered the by the way are they paying for this uh advertisement i hate giving it away for free i'm gonna make a few quick calls

it's widely considered the best manual juicer for lemons and limes and there's this kind of an end note there if you hover over it it says there's a source which is a publication called serious eats and they had an article the four best manual citrus juicers of 2024 it goes on to explain some key advantages it has some other recommendations the kitchen aid citrus squeezer is there if you're on a budget they mentioned zach designs citrus reamer and and we've got a juicer, a squeezer, and a reamer so far. I guess those are the same thing. You know, I don't know, but I'm not sure I want to look that up on Google images. If I were alive, I know which one I'd prefer. Okay. So the point here is that I get a few paragraphs, some bullet points, and I'm done.

My question is answered. What I'm not doing here is I'm not clicking on links and going to other places to find the answers for myself. Now, let's run the search at Google. What's the web address again, Jackson? Oh, that'd be google.com. And here is the classic Google presentation across the top. I've got this row with pictures and it says they're sponsored.

These are all links. It's basically like I'm looking at a shopping site, right? This is a shopping presentation. I can click on any one of these links and I can go to William Sonoma. I can go to Pottery Barn. I can go to William Sonoma. I can go to Pottery Barn. I can go to Amazon. And then below those product displays, I have another set of sponsored links. There's one here from Food and Wine with their review. 2024 is best citrus juicers. And then as we scroll down this long page, we get links and links and links. Other questions that people

are also asking. Apparently, some people are asking, can you use a lemon juicer for limes? I feel like I can tackle this one. Give it a shot. Give it a shot. What's the worst? The time that it takes you to Google it, you can find that for yourself. Live dangerously. You know what? Maybe I spoke too soon. When I click on that, there's something here from Consumer Reports that says yes and no. You can certainly fit a lime into a lemon squeezer, but not always the opposite. Thank you, Consumer Reports. And so you get the idea here. There are more links to discussions and forums and articles. There are plenty of to discussions and forums and articles. You know, there are plenty of links here that are not promoted.

They just happen to show up on the list. Okay, so what's the big difference between those two? I would say clickability, right? Google is kind of the starting point for your click tour around the internet to find the information you're looking for. Whereas when you go to perplexity.ai, they give you the answers up front. They're also not sponsored. So, you know, Google, you're getting more of a pitch and perplexity, you're just getting what you ask. Maybe you want a pitch. Maybe you're in the mood to shop and browse and

you want people to try to sell you something. I mean, maybe you're looking for shoes and you want to see all the pictures and so on. That's fine. But some people just want answers to their questions and they get that in a more direct way using AI from perplexity. I want to give you one more example because that's a product search, but sometimes you go to the internet looking for just explainers. What's something that you need explained to you, Jackson? Give me a burning question. I mean, that's not about something that's burning. Talk to your doctor about that. But just a question that you're very curious about.

What's going on underneath the escalators? What's going on underneath? The stairs just, they disappear. I don't know what's happening down there escalators so perplexity again gives you text and it's pretty readable it's broken up with little subheads and bullet points and says underneath escalators there's a complex system of mechanical components that allows the steps to move smoothly and safely. Here's what's typically found. And they have different items with explanations.

They talk about the step chain and tracks, the comb plates, lighting, motor and gears, the truss, and so on. I think that's everything you probably ever wanted to learn on the subject. Now, when I type the same thing in at Google, it doesn't quite get what I'm asking in the same way. I mean, there are videos and one of them is inside of underneath an escalator. That seems relevant. There's another one, how to survive a malfunctioning escalator. Another is called 10

interesting facts about escalator accidents. No, thank you. But maybe I need to ask the question in a more direct way. So I changed it to how do escalators work and there i get just what i'm looking for there's an article from a publication called how stuff works and it's titled how escalators work there's an article of the same title from a company called peak elevator which i gather is in the parts business and there's another explainer from a publication called Wonderopolis. But in each of these cases, I have to click to go to the article. Okay, so what's the significance of this? Alphabet as a company posted more than $80 billion of revenue in its most recent quarter, and more than three quarters of that came from

advertising. And a key way that Alphabet makes money in advertising is through promoted links. But what happens if AI makes search so smart that search is answering our questions before we've clicked? Can Alphabet still make the same money in search in a less clicky world? And quick follow-up, how are publishers going to survive if search users are no longer clicking through to websites for information and seeing those ads and possibly buying those subscriptions? We're going to hear in a moment from Brent at Jefferies about that. And the real answer is we'll all see because because as Hill explained, we don't yet quite know how search is going to evolve over the next few years. But let me give you two things that we know now. One is that Google is integrating AI in its core search platform. It has this model

called Gemini, and it announced this month that it's rolling it out everywhere. You might start to see a different look on some of your search results. Google has this little video demo of someone searching, how do you clean a fabric sofa? You still end up with a long scrolly page. There are sponsored links, product displays for nature's miracle stain and odor remover, for example. There's a link to a publication called Merry Maids and they have an answer on their site. But at the top of the results page, you get a text explainer. There are tips there on vacuuming, spot cleaning, using baking soda, using a fabric upholstery cleaner. I guess if I had to describe this, I would say it's a typical Google search, but it seems to be wearing a

perplexity hat. You get that AI result before you come to all your links. Google says, our custom Gemini model can take the legwork out of searching. Now hold that thought, taking the legwork out of searching, because it also explains in a blog post, we see that the links included in AI overviews, that's the name of its new search presentation, the links included in AI Overviews get more clicks than if the page had appeared

as a traditional web listing for that query. It also says, as we expand this experience, we'll continue to focus on sending valuable traffic to publishers and creators. So does that make sense? Because it doesn't totally make sense to me. If you're taking the legwork out of searching, Jackson, what is the legwork of searching? It's really in the finger work. The finger work.

It's really the clicking, right? It's the clicking. Clicking and scrolling. Yeah. So how is it that you're taking out the legwork, but you say you're getting more clicks? I think the clicks are the legwork. I think you have a point. It sounds like Google is talking out of both sides of its Google hole.

But maybe the idea is that it will be able to tell based on the person and the circumstance and the search. When is it that people just want the answers right up top and they have no patience for links and clicking around? And when is it that people might like to browse? Maybe they want to shop. And Google has been doing this for a while with sports standings, where if you search up a team, it will just give you the standings right there without having to click. Yeah. And whether I've seen it, it's already had some things where it gives you the info and you don't have to click through. But as it builds that more broadly throughout search and this AI capability to better understand real world questions, it kind of remains to be seen.

A, what's it going to mean for Google's advertising? And B, what's it going to mean for the whole ecosystem of companies and publications that depend on Google for clicks? By the way, if you search perplexity.ai for what effect will AI have on Google's profitability, it has a decent explainer on the subject. AI could improve the relevance and personalization of search results. It could even increase user engagement and add revenue. But it also might reduce the need for traditional search engine optimization. It could disrupt Google's enormous advertising business that relies on websites paying for visibility.

And that's the delicate dance for Google. It has to roll out these AI capabilities to keep up with these small, young upstarts. It's maybe the first time in decades that it's faced a real threat to its dominance in search. So it has to do this, but it has to do it in a way that preserves its search economics. And the numbers are so large there that that's a lot of preserving. That's where things stand now. I'll mention one other thing, and this is less about

Alphabet than it is about my industry and how companies will respond. In fact, it has to do with my company, News Corp. That's the owner of the Wall Street Journal and Barron's. This week, they announced a big content licensing deal with OpenAI. So that's one way that publishers can potentially adjust. Remember, AI needs the content to come up with the answers. So one way to make money if AI is disrupting the clicks business is to just charge AI for feeding it. And that's enough chit chat for me before we get to our conversation with Brent. Maybe a good place for a commercial here, wouldn't you say, Jackson? I think so. Welcome back. Alphabet stock trades at 23 times this year's projected earnings.

It's making good money and growing nicely. I want to know what AI means for the future of Alphabet's business and the stock. Let's hear now from Brent Thill. He's an analyst at Jefferies. He has a positive rating on Alphabet, but it's not his favorite of the big internet stocks. And Brent describes himself as an AI realist. He says the boom is already hitting in chips, but it could take longer than people expect in applications. Let's listen. The big deal is that there are so many other tools that consumers and enterprises can use now Let's listen. in Atlanta airport, you can figure out, do I clear customs leaving Canada and Toronto, or do I have to clear in San Francisco? You can get reviews of going on a trip with some friends. What's the best resort to stay at for families in South Florida? You don't have to just go to Google anymore. I think the plethora of new solutions that consumers have a choice are,

for the first time, creating some havoc inside Google. And we think Google will answer, and they have to act quick because Microsoft beat them to the punch. Amazon is going after this. You have a plethora of startups that are trying to go after this. And for the first time, they're really uncomfortable because there are new choices that are arising that are really good, like really good. So speaking very broadly, traditionally, we put a search into the box on Google and it gives us a list of links. These are places we can go on the internet and we can see is, does that page have what I need? Does this page have what I need? So, you know, we move around the internet.

And somewhere on that list of links, there might be sponsored links. And Google gets paid that way. And other companies, maybe publishers, for example, have designed their whole businesses around how can we appear in a favorable position in Google's list of links. But now with AI answers, if the answers are smarter, don't we just learn what we need to know right there and we don't have to hunt and search around the internet? And doesn't that make it more complicated for Google to sell ads on its own website as well as all these other hangers on for getting clicks for their businesses?

I think it does. And I think that if you even use the example of searching for clothing or looking for travel, you know, Google was the dominant place to go. And now if you even look at what Meta is doing with Instagram, like the ability to now search Instagram for what your friends, where your friends travel, you probably are friends with your friends for a reason because they like to travel in the same spots. Well, where are my friends traveling? And you can search Instagram over time. That hasn't been the case in the past. And so what we're hearing from advertisers is that Google still remains stable inside their advertising budgets, but others are gaining share faster.

Meta, for example, is gaining share because the relevancy and the interaction of that engagement is higher. We are hearing from advertisers that they're looking for every reason to spread their dollars around. They haven't had any reason to leave Google. Currently, I don't think they're leaving. Going forward, this is going to be a more compelling, interactive experience. And if the experience is more interactive, people transact. They transact, the advertisers are going to spend more money there. And so that is an example where we're hearing real world that Meta is taking some share away incrementally on advertising budgets from Google. And you've seen really good numbers

out of Meta to support it. Now, Alphabet has said, don't worry, we've been testing these features and we find that people are more engaged on the internet as a result of these. They, you know, they do the same thing. They behave the same way that they have in the past. And you're birated on Alphabet. Does that make sense to you, that explanation? Do you think they're making too light of the challenge? What do you think? I think they're doing a really bad job communicating. They've never done analyst A. They don't give you guidance in color in terms

of the numbers. Many of our investors are disappointed in their leadership and how they've acted upon the whole AI movement. As you know, many of the AI demos have gone haywire and not produced the right result, and they've had to apologize. I think that they have more behind the scenes. I think if you sat in front of the board and you said you did these three things, I think Alphabet stock would go 15% higher in a nanosecond because they're basic things. Communicate, share the stories, offer more color. They own this asset called YouTube. Why not do an analyst day around AI on YouTube instead of bringing everyone into a room and say,

for Wall Street, here's actually what we're doing. Here's where we think the misperceptions are. Here are your top 10 questions and address them. Do they do that? No. And any improvement, Do they do that? No. And any improvement, in my opinion, would lead to more upside for the stock. Google is dominant in search and Apple has a dominant position in these handheld devices everyone is carrying around. And I read about a coming partnership in AI between the two. What do you make of that?

And who's the winner in that? Or is it both? Is it even? What do you think? I think everyone is believing that Apple's behind. As a big user of Apple products, there really hasn't been a ton of innovation in the software and the AI stack. There's obviously continued innovation in the core, but there's nothing that's really jumped out at you. When you turn your phone on, you look at your Mac Air and say, wow, this is incredible. And what Microsoft just did launching these new AI computers has caused a lot of people

to kind of say, well, what's Apple's answer? Is it a partnership with Microsoft and OpenAI? Is it a bigger partnership with Alphabet? Clearly, Apple needs a little more spice in their AI life. And today, they don't have it. And so they got to do something, whether it's organic, whether it's a partnership, it's an acquisition, but they need to step up their game relative to what the other industry leaders are doing. It's important because if Apple gets the AI layer right and you open up your phone in the morning and all of a sudden your AI assistant's feeding you information and telling you about the weather and telling you about how long it's going to take to work because there's construction or what have you, it creates higher engagement on the device and it creates a stronger bond to that device. It's kind of the same analogy I'd use for Alphabet.

I think it's coming. I think it's underneath the hood, but they haven't really popped the hood and shown you kind of everything underneath. They're just basically kind of telling you it's coming. It feels like all of the big internet companies are gearing up for some big release, like a major movement on the AI front. I also feel like the public feels like, well, I've heard a lot about that, but I don't see it a lot in my life directly. Where do you think we are in terms of people's expectations? I'm talking about the ordinary person on the street in terms of their expectations for AI and what we're going to actually see from it in the year or a couple of years ahead. Is this a big inflection coming? Every major CEO is indicating

that this is one of the biggest shifts we've ever seen. It will impact every one of our industries. Alphabet's CEO said that the AI movement will be bigger than the internet itself. Everyone scratches their head and says, why? And it goes back to, I think going forward, AI will be easy. It'll be consumable. It won't be technical. And Microsoft and OpenAI and others are starting to showcase this where it's not just a chat bar, but it's voice. It's basic interactions. It's like having a conversation with a human being, and it becomes less technical.

And that enables someone that works on a factory floor or someone that drives a truck or someone that could be a CEO of a company. It could go all the way from a barista at Starbucks to a CEO. How do they interact? How does it change and transform and help their life? But I think we're going to get to a point where it's going to be consumable by everyone, by my parents who are in their 80s, by my kids who are 11 to 18. And I think everyone is going to be changed by it, but it's going to take a long time. And as they've said, we're going to basically overestimate the near term and underestimate the long term. And I think that really holds well here. We have a lot of hype.

I would just say, I've never seen boards behave the way they are. So you can talk to companies in tech and they get all excited and it's all slideware and excitement and hype. But when the boards of these companies are all getting together and saying, we have to embrace this, we have to change our way, we have to get in front of this. We're seeing boards, CEOs, every major line managers, they're all starting to think about how is this going to impact them and they have to embrace it. Which stocks in your coverage do you like the most right now? And how much of a factor is each company's position in AI in forming those decisions? Our AI framework is you need three things.

You need users, you need data, and you need capital. And there are only four companies on the planet that have it. So for the enterprise, we like Microsoft and Amazon. And for the consumer market, we like Meta and Alphabet. So there are four names that we like, and we group them into enterprise and then consumer picks. And so for the enterprise, Microsoft is laps ahead of everyone else. They were the first one to announce they have the best partnership with OpenAI. They have the most momentum, and they can go up and down the stack from apps to infrastructure to security. They have a broader stack to take advantage of AI than anyone in the

enterprise. So Microsoft's our favorite pick. Amazon is a little bit behind, but we think they're going to make up ground. The new leader at AWS has incredible accolades around his product leadership. And we think that will help. And we expect Amazon to play catch up to Microsoft. And then on the consumer side, meta is still our favorite story. We think the world of the metaverse is going to tie into this, which is these rich interactive experiences that AI will let us have as consumers will create more advertising dollars flowing to the platform. So if it's a more compelling experience to book travel

or to try and close or buy sporting equipment for your kids, you're going to go there. And if you go there, advertisers follow where people are at. The marketplace is more vibrant. And so we think Meta is going to have the most interactive, rich environment.

They will benefit. And Google will benefit. They're behind, as we've said. They're probably the furthest behind in perception, but the product is probably a lot further ahead than the perception. So we like that position as well. So those are the four names that we think are extremely well positioned. This is not part of your job description, I think, to have an opinion on this.

So you might not. But just for people who are interested in these businesses where the name of the game has been trying to get a favorable position in search. That includes not only my industry, the news industry, but many others. What happens? Does this become very disruptive for these companies as AI takes over search? for these companies as AI takes over search? The kind of person who's like a search engine optimization person, is their job now obsolete? Or what do you think happens in the future? I think search will exist. I just don't think it's going to exist in the same way it has in the way that we thought about a bar. It's going to be embedded in simple voice requests, simple, you know, assistance that

pop up. You're going to be abstracted. You may not even know that you're going to Google. And so I think we're going to all have these assistants that help us. We're still not there yet, but I think this creates an opportunity for the competition. And we're seeing this with these small teams that are building an incredible product that I think it's a scary place right now because I think the whole industry is getting kind of turned upside down and no one really knows exactly what it's going to look like three years from

now. We know what it's going to look like this year and Google will be just fine. But I think three years from now, it could look radically different and we think Google's going to react. And I think it's making them better because sometimes you're a better company when you have competition. They haven't had competition for quite some time. The number one question investors are asking right now is the AI trade has been very clear.

Today, AI is all in infrastructure. has been very clear. Today, AI is all in infrastructure. So if you take ANET, which is Arista and networking and Dell and NVIDIA and ARM, and even if you want to throw in some of the energy companies, TL&E, who is partnered with Amazon and others, if you look at that cohort of stocks, they're up 40, 50, in the case of NVIDIA, up 92%. So as all the AI industry leaders are saying is AI is living in the infrastructure. You have to build a foundation in the infrastructure for the applications to work. AI is not in the application. So all you need to do is look at the SMH, which is the semiconductor index.

It's up 34%. The software index, which is the semiconductor index. It's up 34%. The software index, which is the IGV, is up four. So the scoreboard says in AI, four to 34%. That's your year-to-date return. So the number one question we get is, when is the AI infrastructure semi-led first outperformance in stocks going to come to software? When's it going to come to other areas of technology? And if you look at the underperformance of Apple, the underperformance of Microsoft, the underperformance to other names,

that's a central question we're getting. We think it'll come. But as we've said, when you arrived in Telluride and you saw those beautiful mountains during the gold rush, you had to buy picks and shovels to find the gold. You didn't just create a gold store. And so everyone thinks there's gold everywhere. And the reality is the AI gold rush is really just an infrastructure. Everyone's just buying all the infrastructure. The risk is, what if this doesn't work? What if all these AI agents go rogue? What if all the AI is like the paperclip? Remember clipping the paperclip from Microsoft? You want to turn it off?

And we've heard of customers that have been deactivating Microsoft Copilot on their desktop because it's annoying. It's not the right answers. It's not producing the right results. So I have been what I call a more balanced AI analyst, which is don't believe all the hype. There are examples of AI not working and there's a real risk. What if this doesn't work the way these companies are pitching? And as they say, it shows well, but it's got to go into implementation. And 95% of AI projects are what we call proof of

concept or POC. 5% are real implementations. What if all the big hyperscalers are like, consumers don't want this. Enterprises are like, it ain't working. They think it's going to work because they want to sell you the next thing. But what if it doesn't? it's going to work because they want to sell you the next thing. But what if it doesn't? Thank you, Brent. You know, Jackson, Brent mentioned about some of Google's AI demos going haywire. Yeah.

I think one of the ones he might be referring to was a little over a year ago, and it was when the company tweeted a video demo of its Bard chatbot answering a question about the James Webb telescope. And in the demo, it said that that telescope, quote, took the very first pictures of a planet outside of our own solar system. That is apparently not true, it turns out. Apparently, the first was something called the European Southern Observatory's Very Large Telescope back in 2004. That has been confirmed by nasa and it might not sound like a big deal that bard got something wrong in this video demo tweet on twitter but the stock lost seven percent in a day back then one commenter on the tweet and jackson you better have your hand ready on the bleep button for this. He called it misinformation at scale, bulls**t as a

service. Now you didn't bleep the bull part of that, right? You got to keep the bull so that listeners know what the commenter is saying. Yeah, bull was unbleeped. But you definitely have to bleep the s**t. That's the important part. Got you covered. Again, let's point out that was more than a year ago and it was this chat bot, not Google's new AI rollout over search. And we all know that AI isn't perfect, but we'll see how it goes. I guess the good news for Alphabet is that if AI turns out to be a bust for now on the application front, meaning this stuff doesn't work nearly as well as people

thought it was going to work and it takes a few years for it to come around, then Alphabet is stuck with what? An enormously lucrative business in traditional search advertising, which is not such a bad hand. We'll see. Thank you all for listening. Jackson Cantrell is our audio producer. He's an escalator enthusiast.

He's curious.ator enthusiast. He's curious. You can subscribe to the podcast. You can rate it, review it on Apple. You can send us a question if you want us to answer it in a podcast. Tape it on your phone. Email it to jack.how. That's H-O-U-G-H at barons.com.

What if I ask perplexity, who is Jack Howe? Do I want to know? I think I want to know. It says Jack Howe is an associate editor and writer at Baron that's that's true blah blah blah yeah yeah yeah it says however there is also a different jack how who was an oklahoma native and pioneering ear surgeon wait founded the how ear institute in ok Oklahoma City? Oh, my God. This guy's such a better Jack Howe than I am. I feel like perplexity is even casting a little shade on me, it says.

So, in summary, there are two notable individuals named Jack Howe. One is a current financial journalist at Barron's, and the other was a pioneering ear surgeon from Oklahoma who made significant contributions to microsurgery for hearing restoration. I know when I'm beating the Jack how game, that's it for us. See you next week.