Is the AI Boom a Bubble? Here's the Stock I'd Buy Either Way.

Despite AI enthusiasts' enthusiasm, there exists a valid worry about an AI bubble. The stock indices have reached near record highs, and the CAPE ratio stands at 41, a level previously encountered during the dot-com bubble. However, these metrics do not necessarily indicate that all AI-oriented technology stocks are overvalued. Exiting the sector entirely might not be the best strategy for investors.

The aftermath of the dot-com bust demonstrates that holding key industry stocks proved profitable when internet stocks recovered. This precedent could suggest that investing in Alphabet, Google's parent company, could yield substantial gains. Upon closer examination of Alphabet's financials, the company's valuation may not appear as favorable as initially thought.

Its P/E ratio stands at around 18, partly due to a 300% stock price increase since early 2023, driven by the surge in generative AI competition. Although the company's recent $195 billion to $205 billion in capital expenditures (capex) spending has raised concerns, given Alphabet's significant liquidity, it has resorted to the debt market to fund these investments.

The income statement reveals that 98% of the $139 billion in income before income taxes in Q2 2026 was derived from "other income." Most of this gain originated from unrealized gains on Alphabet's equity investments. While the company generated nearly $120 billion in net income from operations in that quarter, its operating margins are not as impressive as some AI counterparts.

This situation could potentially lead to operating losses if unforeseen circumstances cause AI growth and spending to plummet. Additionally, Alphabet's traditional cash cow, Google Advertising, now accounts for only 68% of the company's revenue, a decline from its historical dominance. This decline might have contributed to Alphabet's $53 billion in free cash flow over the past year, which is still impressive considering that metric excludes capex.

Despite this, investors must acknowledge that many competitors in the hyperscaler space have either turned negative or are struggling to maintain positive free cash flow. Consequently, Alphabet appears better positioned to adapt to the AI race and control capex during downturns. Moreover, the AI race is transforming Alphabet into a leading AI company.

Google Cloud now accounts for 21% of the company's revenue, up from 14% a year ago, a trend that aligns with the surge in Google Cloud's revenue, which increased by 82% during the same period. This growth indicates that the heavy spending on AI is beginning to pay off. Furthermore, Alphabet's AI platform, Google Gemini, has held its own in the highly competitive AI landscape, pitting Google against OpenAI's ChatGPT and Anthropic's Claude.

CEO Sundar Pichai has expressed optimism about Waymo, Alphabet's autonomous vehicle arm, potentially becoming a significant revenue source by 2027 as driver adoption of this technology increases. Despite the current valuation appearing slightly attractive when excluding one-time events, Alphabet's forward earnings multiple of 29 is slightly above the S&P 500's average P/E ratio of 27.

This valuation could result in limited downside if business conditions unexpectedly deteriorate. Overall, investing in Alphabet stock, irrespective of the AI industry's bubble status, appears to be a prudent choice. While the P/E ratio may appear deceptively low, and capex spending might seem concerning to some AI enthusiasts, Alphabet's strategic investments in AI have undoubtedly bolstered its competitive edge.

This strategic move is projected to benefit Alphabet in the long run, offering investors a well-positioned stock to safeguard wealth and deliver long-term growth driven by AI advancements.