Alphabet (NASDAQ:GOOG)(NASDAQ:GOOGL), the parent company of Google, once again delivered strong earnings growth in the second quarter of the year, but the stock sank after management announced plans to increase spending on artificial intelligence infrastructure.
Shares of Alphabet traded roughly 7.1% lower, as of 10:24 a.m. ET. Second-quarter revenue of nearly $119.8 billion rose 24% year over year, while operating profit of $40.7 billion increased 34%.
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Revenue topped Wall Street expectations by close to $3 billion, while adjusted earnings per share of $2.85 missed consensus estimates by $0.04.
Investor focus remains on capital expenditures. Investors have become quite squirrely as hyperscalers like Alphabet go all in on AI, committing hundreds of billions of dollars to large-scale infrastructure projects.
Here are 15 billion reasons why Alphabet stock is sinking today.
Image source: The Motley Fool.
Raising already high capex guidance
Heading into the quarter, Alphabet's full-year capex guide was already a staggering $180 billion to $190 billion.
But on the company's earnings call, Alphabet's CFO Anat Ashkenazi raised the guidance to $195 billion to $205 billion, increasing the midpoint by $15 billion.
That could put it above Amazon's $200 billion 2026 capex guidance, which had been the highest among the hyperscalers, although Amazon has yet to report earnings.
"The increase in the range is primarily due to an acceleration in the delivery of capacity to meet growing demand," Ashkenazi said on Alphabet's earnings call. "As we previously shared, we continue to expect our capex to increase significantly in 2027 and will provide more details at a later date."
Later in the call, Ashkenazi said the company remains in a "supply constraint environment" and is seeing strong AI demand across the company. The company will continue to invest if the long-term return on investment (ROI) remains compelling, she said.
But it's likely the short-term ROI that has investors on edge.
Not long ago, capex announcements like this would have sent the stock soaring, but investors now have doubts over whether this kind of exorbitant spend can really yield adequate returns,
Capex spending is a drain on free cash flow, and the company just saw free cash flow flip negative in the second quarter.
Wall Street analysts had mixed views on the quarter. Baird analyst Colin Sebastian, in a research note after the release of earnings, said he expects "upcoming margin pressure."
Meanwhile, Valoir CEO Rebecca Wettemann said other strong parts of the earnings report "should calm some market fears about AI overspending."
Wettemann is referring to the company's search, advertising, and cloud units, which posted year-over-year revenue growth of 17%, 13%, and 82%, respectively.
Bulls hope management knows what they are doing
Unfortunately, at this moment, it's hard to know whether the AI bulls or bears will be right.
On one hand, the people running Alphabet are some of the smartest in the world, so if they are willing to invest this much in AI, one would think they feel pretty good about it. And revenue has surged in several areas heavily influenced by AI.
On the other hand, free cash flow just turned negative, and margins could be next. This is just the beginning for capex, too, if you believe management.
I think if you are going to invest in AI, Alphabet is not a bad stock to bet on, given its track record and many businesses that were crushing it before AI.
But it's also important to recognize that even the best can be wrong, which is why all AI-driven companies carry some risk right now.
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Bram Berkowitz has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet and Amazon. The Motley Fool has a disclosure policy.
15 Billion Reasons Alphabet Shares Are Sinking After Reporting Strong Earnings Growth was originally published by The Motley Fool
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