To The Moon

Can AI Search Destroy Google's Value?

For those of you who have been living on the moon for the past few months, AI chat bots and specifically ChatGPT have been taking the world by storm. ChatGPT launched in November, and by the end of January reportedly had over 100 million active users. This milestone cemented its status as the fastest growing consumer application in history and shows the demand for a newer and potentially better way to seek information online. Whether or not this marks the beginning of a paradigm shift remains to be seen, but the emergence of this new disruptive technology raises the stakes for all companies that generate revenue via internet searches and ads.

Open AI (the private company behind ChatGPT) has sparked an arms race in the space, as Google recently rushed their own chat AI search product to market. Microsoft was an early investor in Open AI in 2019, and recently announced an additional $10B in funding for the company. The quick response by $Alphabet(GOOGL)$ to demonstrate their own AI capabilities is a clear signal that they view ChatGPT as a threat. Google's demonstration was fraught with issues, including factual inaccuracy. Despite its own shortcomings such as capacity and accuracy, ChatGPT currently appears to be miles ahead of the competition. Technology in this space is evolving quickly and will likely continue to improve as time goes on. Competition among new entrants will also likely increase, creating the potential for even more substitutes to Google's search algorithm. Is this the beginning of the end of Google's dominance?

"Googling" something for information has become the accepted standard. The company currently has a stranglehold on internet searches, with about 84% of total market share as of the end of 2022. Advertising represented about 80% of Alphabet's (the holding company of Google) total revenue last year, and the majority of that is derived from its Google Search function – $162B of the total ad revenue of $224B came directly from Google search, with the remainder being generated from YouTube, Google Cloud, and Network Members. Despite the company's continued efforts to branch out into other revenue centers, search remains its golden goose. A significant hit to growth and/or profitability within this segment of the business would likely be catastrophic for $Alphabet(GOOGL)$  investors and its stock price.

Early investors in Google are still very much in the black, despite the 45% peak-to-trough decline that began last February. Even after this swoon, retail investors who purchased shares near the time of its IPO are still up nearly 40x on their initial investment. For an early buy-and-hold investor who avoids periodic portfolio rebalancing to reduce taxes owed, it may well be that Google represents a substantial portion of their total wealth. The recent events that have transpired around AI chatbots raises the stakes for someone sitting on a concentrated position in $Alphabet(GOOGL)$ .

Numerous studies have shown that holding a concentrated position will eventually lead to underperformance versus the market.Trends change, new technologies emerge, and companies that once dominated a particular business eventually will be left behind. This isn't a new phenomenon – history is littered with stories of companies that seemed invincible, only to give way to new trends and disruptors that discovered a better way to solve problems.

The good news for someone currently sitting on a concentrated $Alphabet(GOOGL)$ position is that there are ways to reduce their holding without getting bludgeoned by capital gains taxes. Options are often (and rightly) viewed in a negative light among retail investors, as they can be very risky and lead to substantial losses. Options are complex and can be intimidating to even the most seasoned investor. What many people don't realize, though, is that options can also be powerful tools for tax optimization and hedging within a portfolio. When correctly implemented, an option overlay strategy may completely eliminate tax liability on certain concentrated positions, while simultaneously hedging downside risk. There are of course transaction costs involved, as well as advisory fees in the case of an overlay strategy, but the ability to exit these positions tax neutrally while also reducing portfolio volatility can have a substantial positive effect on long-term capital appreciation.

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