What Does Alphabet's Plunging Stock Tell Us?
One of the most profitable companies in the world went free cash flow negative in the second quarter, and investors are worried.
$Alphabet(GOOG)$ ( ▲ 2.34% ) shares are down 20% from their high in May, and there’s good reason to ask some serious questions. No, the market isn’t worried about where Alphabet is going to get the $200+ billion it’ll spend on capex this year or the (maybe) $300 billion it’ll spend next year. There’s a great cash flow business to fund most of that, and debt can fill the rest of the gap.
The market is worried that the return on Alphabet’s spending and the spending of every hyperscaler and neocloud will have low or no return at all.
~$1 trillion in spending this year, and even more next year, needs to generate a return. Assuming a 10-year blended depreciation, a 10% return on asset expectation, and a 10% gross cost to capex calculation, there would need to be about $300 billion in incremental revenue to justify this year’s AI investment.
Bump that up to $500 billion, or more, for next year’s revenue bar.
Anthropic, the biggest company in AI, expects to generate about $55 billion in revenue this year. Alphabet — one of the biggest companies in the world — generated $446 billion in revenue over the past year.
Is there a problem ahead? More on that in a moment.
Alphabet’s Big Change
Let’s start with the good.
Alphabet’s core business is growing, although growth isn’t incredible right now. Search and YouTube are slowing a bit, maybe because advertisers are pulling back, and maybe because of Google pushing AI Overviews.
But no matter how you look at it, a core business with $154 billion in operating income is a good business.
But the core isn’t what the market is focused on.
Where the focus is today is Google Cloud, which includes most of Alphabet’s AI business. That business grew 82% in Q2 and has improved operating margins. Wow, right?!?
Alphabet BETTER have a high growth cloud business if it’s going to justify putting $45 billion of capex into the ground in a single quarter, rising to ~$75 billion at some point next year.
So, here’s the question.
How much growth and profit will Alphabet have to generate to justify spending $200 billion this year and ~$300 billion next year on capex?
Is there $500 billion in AI spending to be had?
Will there be an ROI?
What happens if/when token costs fall?
Ironically, Alphabet’s earnings raised more questions than it gave answers because the market seems to be asking the questions I’ve been asking for over a year.
I sold some of my Alphabet stock in early July, and I may trim even more after this result. Even winning in AI may be value-destructive, and Alphabet seems hellbent on winning, no matter the cost.
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