What Alphabet’s Stock Drop Tells Us About the Market Today
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What did Alphabet’s Q2 free cash flow surprise reveal about its AI spending?
What do Alphabet's earnings tell us about the future of the market? Motley Fool Hidden Gems Investing starts now. Welcome to Motley Fool Hidden Gems Investing. I'm Travis Hoyum, joined today by Lou Whiteman and Jason Hall. And guys, we got to talk about the big story of the week. That is Alphabet, their spending plans and the implication on trillions of dollars of value of market cap out there. The big thing, I was looking at what the stock has done over the past week or so, and since early Monday morning, shares are actually down 11%. So this is a pretty big move for a lot of people who have this in their portfolio, whether it's through an index or through the individual shares. But Lou, the big story here was that the core business is doing okay, but they're spending even more than expected on this AI build-out, and they're now free cash flow negative, which is a huge change for them historically.
Yeah. So, look, I'd say the core business is doing better than OK. The cloud revenue is up 82 percent. The cloud revenue is doing amazing.
But, you know, search, the growth rate is slowing a little bit. YouTube was a little bit weaker than it's been in the past. So I'm saying those other businesses that actually drive the cash flow.
And look, the spending part, you're right. The spending is what we have to focus on. And I think that spending is fine until it's not. I don't think the market is really trading off on this spending number. This was telegraphed. It's not great that we're going into free cash flow negative, but Right now, there needs to be an answer of one of two questions, and Alphabet doesn't seem to have an answer to either. One is, when will all this spending turn into a return on invested capital, or when will it slow down? And right now, both of those, the answer is eventually, okay? Let me paint the bare picture here. And I don't know if I necessarily believe this, but I think this is what's weighing on markets right now.
We tend to think of Alphabet as a great capital allocator, but massive cash generation covers up a lot of sense. There is a whole website called Killed by Google that lists more than 300 things Google has tried and failed. Some we remember, Google+, Google Reader. I still miss Google Reader, but, you know, most we don't. What's the difference between Google Reader and AI? Google Reader didn't cost all that much money. None of this mattered relative to the cash that they were generating. What's different now is, is this latest product, this latest initiative is consuming all of the cash they're making and more. I don't think this is the initiative is going to go the way of Google Reader, but anything short of a massive, you know, what return on invested capital over time has been 15 percent.
They got to make a lot of money on this or they need to slow spending. And I think that's sort of what investors are grappling with right now.
Yeah. Jason, do you look at this and see more risk in Alphabet? Because obviously the market has got more questions today after earnings than they did a week ago. But you can make an argument on both sides of this.
Yeah, and I think largely, and for the record, I own some NVIDIA, but in terms of like the real hyperscaler businesses, Alphabet is the only one that I own individual shares of. And I think looking at that negative free cash number, the fact that they are deploying so much CapEx, there's a lot of bullishness there for me because it's happening at the same, this is not like there's a collapse in operating cash flow. Everything else is working fine. Google Search, despite some deceleration there, despite the reality that we know that people are using LLMs now, including OpenAI and Claude for more search related things. We know that the ad revenue is holding up very well for Google Search. YouTube is helping drive some of that.
But YouTube is also doing good. Again, like I said, not great, but doing good. And look at Google Cloud. Revenue almost doubled in that business. The kind of more AI-focused specific part of that was up like triple.
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