Cathie Wood says software is the next big AI opportunity — 1 spectacular stock you’ll regret not buying if she’s right

Cathie Wood is the head of Ark Investment Management, which operates a family of exchange-traded funds (ETFs) focused on innovative technology stocks. Last year, Wood said that software companies could be the next big opportunity in the artificial intelligence (AI) industry. She predicts they will eventually generate $8 in revenue for every dollar they spend on AI data center chips from vendors such as Nvidia.

And Wood has put her money where her mouth is. Since making that call, she has scooped up AI software companies like xAI, Anthropic and OpenAI through private equity fund Ark Venture. In addition, Ark ETFs own several AI software stocks, including adze, Palantir, Meta platformsand Microsoft.

If Wood is ultimately right about AI software companies, here’s why parent Google Alphabet (GOOG 0.52%) (GOOGL 0.77%) could be among the biggest winners.

Image source: Alphabet.

Alphabet transforms Google Search using AI

Alphabet is a tech conglomerate that is home to Google, YouTube, self-driving vehicle company Waymo and a host of other businesses. Google search accounted for more than half of Alphabet’s $84.7 billion in revenue in the second quarter of 2024, thanks to its 90 percent market share in the Internet search industry. But that dominance faces its biggest test ever because of AI.

AI chatbots like OpenAI’s ChatGPT provide direct answers to users’ questions, giving them quick access to information on almost any topic. Google, on the other hand, requires users to browse web pages to find the information they need and generates revenue by charging companies money to promote their websites in search results. As a result, the traditional search model is very important to Alphabet.

But instead of defending what might eventually become obsolete, Alphabet decided to make drastic changes. In many cases, users running Google search queries will now receive AI-generated, text-based answers on top of web search results to give them faster access to information. Google also launched AI Overviews earlier this year, taking this concept a step further.

Overviews include text, images, and links to third-party websites to provide more complete answers to Search queries. In addition, with the click of a button, the user can simplify or break down the answers to gain a better understanding of the content. Alphabet has already found that Overview links get more clicks compared to the same links in the traditional search format, so this new feature could be a big driver of advertising revenue going forward.

In addition, Alphabet now offers its own family of AI models called Gemini (and a chatbot of the same name), which can answer complex questions and generate content such as text and images. For an additional fee, Gemini is already available as an add-on in Google Workspace, which hosts productivity apps like Gmail, Docs, Sheets, and more. As a result, it could become a strong driver of subscription-based revenue over time.

Google Cloud is Alphabet’s fastest growing business

Search may be Alphabet’s biggest business, but Google Cloud is growing at twice the rate. It generated record revenue of $10.3 billion in the second quarter of 2024, up 29% from the year-ago period — compared to 13.7% growth in Search.

Google Cloud offers a portfolio of services to help businesses succeed in the digital age, such as data storage, web hosting, and software development tools, among others. However, the platform has also become a leading provider of AI services.

Developers can access the computing power they need to create AI software through Google Cloud data centers. To speed up their progress, they can even use the latest off-the-shelf Large Language Models (LLMs). This includes Gemini and over 130 others from leading start-ups and third-party developers.

Google Cloud is also designing its own data center chips to give AI software developers more options, which helps differentiate the platform from other cloud providers that rely primarily on vendors like Nvidia. Google recently launched its sixth-generation tensor processing unit (TPU) called Trillium, which achieves nearly five times the computing performance of the previous generation.

Most AI developers pay for computing power by the minute, so faster chips can substantially reduce costs. Plus, going back to Wood’s prediction, if Google makes its own chips at scale, profits could be significantly higher when it uses them to create software — or leases them to other developers — because it won’t have to ship billions dollars to vendors like Nvidia.

Alphabet stock is cheap, but there’s a big caveat

Alphabet generated earnings per share of $6.97 over the last four quarters, and based on its share price of $161.85 at press time, trades at a price-to-earnings (P/E) ratio of 23.2. That makes Alphabet the cheapest of all US tech companies valued at $1 trillion or more:

PE report data by YCharts. PE ratio = price-earnings ratio.

But there’s a glaring problem, and it has nothing to do with the company’s growth or its position as an AI powerhouse.

The US Department of Justice (DOJ) filed an antitrust lawsuit against Alphabet in 2020, alleging that the company engaged in monopolistic practices by paying Apple up to $20 billion a year to make Google the default search engine on its devices. Unfortunately for Alphabet, the judge in the case ruled last month and sided with the DOJ.

It is not clear what the consequences will be. Alphabet could have to pay a financial penalty, or the government could force a breakup of the entire company. The latter would create significant uncertainty for investors, as Alphabet would likely have to sell parts of its business to convince the DOJ that it will not engage in anti-competitive behavior in the future.

Many Wall Street analysts say a breakup would be an extreme and unlikely outcome. Technology analyst Dan Ives of Wedbush Securities believes Alphabet will reach a settlement with the DOJ within the next 18 months to end the matter. This could involve a financial penalty and some changes to how Alphabet’s structures deal with its partners.

Absent a settlement, it could take years to reach a final resolution while Alphabet appeals the judge’s decision, so the status quo should prevail for now. So Alphabet stock looks like excellent value at the current price, and if the company emerges from this regulatory situation intact, it could look like an absolute bargain given Cathie Wood’s AI software predictions.