Blowout Q2 But AI Spending Spree Spooked Wall Street
Once again, while the market should have celebrated Alphabet’s (GOOGL) blowout quarter, investors seem more worried. In the second quarter, Google Search remained resilient, Google Cloud continued its remarkable expansion, and profitability improved. Yet, the whole focus was on just one number, which seems to be the current source of concern for AI investors. Currently,…
Once again, while the market should have celebrated Alphabet’s (GOOGL) blowout quarter, investors seem more worried. In the second quarter, Google Search remained resilient, Google Cloud continued its remarkable expansion, and profitability improved. Yet, the whole focus was on just one number, which seems to be the current source of concern for AI investors.
Currently, GOOGL stock has a market valuation of $4.15 trillion and is up 1.62% year-to-date (YTD) but down 10.27% over the past five trading days.
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Let’s examine the reasons investors seem to be worried.
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AI Is Driving Growth, But It’s Also Driving Costs
The market’s reaction doesn’t justify Alphabet’s robust second quarter. The company reported revenue of $119.8 million, an increase of 24% year-over-year (YOY), extending its streak of double-digit revenue growth to 12 consecutive quarters. The company’s most mature business, Search, reported a 17% YOY increase in revenue as AI-powered experiences drew in more users while maintaining monetization. YouTube also continued its healthy momentum. Advertising revenue rose 13% driven by both brand and direct-response campaigns. The FIFA World Cup proved to be a major engagement driver.
Additionally, Google Cloud, which remains the third best global cloud computing platform, saw an 82% increase in revenue to $24.8 billion. Demand for AI infrastructure, enterprise AI solutions, and core Google Cloud Platform services has increased significantly, with cloud backlog now sitting at $514 billion. Earnings soared by an eye-popping 294% YOY to $9.11 per share. For a mature company like Alphabet, its three largest businesses are still growing at a pace few mega-cap companies can match.
Perhaps the most attention-getting number in Q3 was the increase in expected 2026 capital expenditure, which now sits between $195 billion and $205 billion. The company even expects this figure to increase significantly again in 2027 as the company continues expanding AI infrastructure. Furthermore, the spending is not just limited to hardware. Alphabet expects rising depreciation expenses, increased energy costs associated with operating new data centers, and ongoing hiring and marketing expenses connected to AI businesses to eat into margins even as revenue grows. For investors already worried about high AI spending, this outlook raised more concerns.
For years, Alphabet was a company that delivered rapid growth and enormous free cash flows at the same time. But now, to gain a long-term competitive advantage in AI, the company is sacrificing near-term cash generation. Capital expenditures totaled $44.9 billion, which resulted in negative free cash flow (FCF) of $5.9 billion for the quarter. Management even acknowledged that FCF will be under pressure due to ongoing investments in AI infrastructure, rather than weakness in the underlying business. This has worried investors, as free cash flow also supports the company’s dividends.
Dividends, on the other hand, are currently safe. The company even declared a quarterly cash dividend of $0.22 per share, which will be paid in September. And despite the negative FCF, Alphabet made no mention of reducing, delaying, or reconsidering its dividend.
Why Management Seems Comfortable Spending Even More
Despite the impact on near-term cash generation, Alphabet’s management isn’t shying away from spending more. The reason is that AI infrastructure demand continues to exceed supply. Therefore, management stated that to meet customer demand the company has to temporarily rely heavily on third-party infrastructure in the third quarter, even though it will pressurize margins. This is a sacrifice Alphabet is willing to make, as it believes the long-term opportunities of these investments will outweigh the risk.
However, it also appears to be a calculated risk, as Alphabet knows its underlying business remains strong. The company now has nine million developers building with Google’s AI models each month, and the company’s APIs process approximately 22 billion tokens per minute. Furthermore, nearly 90% of Fortune 100 companies now use Gemini Enterprise, with the Gemini app now holding 950 million monthly active users.
The Bottom Line on GOOGL Stock
Alphabet’s second-quarter earnings weren’t disappointing from any angle. At the company’s scale, revenue grew 24%, operating income increased 30%, Search remained remarkably resilient, YouTube continued expanding, and Google Cloud delivered another exceptional quarter with accelerating growth and expanding profitability. However, the market’s concern is that future expansion plans is weighing on today’s cash flows. Long-term investors, on the other hand, understand that today’s higher spending could strengthen Google’s position across Search, Cloud, and enterprise AI over the next several years. This might help Alphabet create the strongest competitive moat in this rapidly expanding AI market.
On Wall Street, GOOGL stock still maintains its consensus “Strong Buy” rating. Of the 54 analysts covering the stock, 45 rate it a “Strong Buy,” four say it is a “Moderate Buy,” and five rate it a “Hold.” Analysts forecast the stock can rise by 36.7% from current levels based on its average target price of $435.25. Plus, its high price estimate of $515 suggests the stock has an upside potential of 61.8% over the next 12 months.
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On the date of publication, Sushree Mohanty did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. This article was originally published on Barchart.com
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