Alphabet shares were firmly lower in early Wednesday trading and are on pace to lose around $100 billion in market value after the Google parent posted solid second-quarter earnings but suggested its AI investment spending would continue to accelerate through the end of the year.
Alphabet (GOOGL) , which is betting that AI technologies will boost the value of its core search business while enhancing its cloud and data divisions, said capital spending for the three months ending in June rose to $13 billion, bringing the first half tally to around $25 billion.
KeyBanc Capital Markets analyst Justin Patterson, who held his $200 price target in check following last night's earnings update, said Google's current quarter outlook is likely to "invoke concerns on whether revenue growth can outpace" longer-term spending.
"Soft trends in YouTube, tough Search comps in 2H24, and capex moving closer to $50 billion are likely to elevate concerns on 2025 estimates for earnings and free cash flow," he added.
That level of spending, as well as modestly disappointing totals for ad sales from its YouTube offering, were enough to clip Google shares in premarket trading, even as the broader second-quarter update was largely impressive.
Alphabet posted a bottom line of $1.89 per share, topping Street forecasts by 5 cents, as overall revenues rose 14% from last year to a forecast-beating $84.77 billion.
Alphabet's bigger risk is under-investing
Cloud division revenues were the standout, rising 28.8% to $10.35 billion, while ad sales were up 11% to $64.6 billion, thanks in part to newly launched AI enhancements such as Circle to Search and AI Overviews.
"We are uniquely well-positioned for the AI opportunity ahead," CEO Sundar Pichai told investors on a conference call late Tuesday.
We are at an early stage of what I view as a very transformative area and in technology when you're going through these transitions," Pichai said. "When we go through a curve like this, the risk of under-investing is dramatically greater than the risk of over-investing."
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CFRA analyst Angelo Zino, who held his 'buy' rating in place following last night's update, said Google's profit margins in the cloud division were impressive, as was the growth rate of 14% in its core search business.
"We would define the quarter as being one where Google executed well on both the top and bottom line," Zino said. "We remain optimistic about AI monetization across its digital ad businesses and across the cloud as new capacity ramps."
Google ad sale improvements
JMP Securities analyst Andrew Boone, who has an 'outperform' rating and a $200 price target on Alphabet shares, also noted YouTube's softer-than-expected ad sales but said the unit is still well-placed to capture more spending over the back half of the year.
"With AI incorporated across Google’s product portfolio as each of its six products with 2 billion-plus users have incorporated Gemini, AI is driving higher user engagement and better return on ad spend for marketers," Boone said.
"Importantly, with AI benefits still early, in our view, we believe search growth is sustainable, and with ongoing cost discipline, this allows margins to expand," he added.
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Wedbush analyst Scott Devitt, who carries an 'outperform' rating with a $205 price target, agrees that AI investments will boost the group's search business, adding that "softer growth at YouTube should overshadow" shouldn't overshadow its transformation.
"Google is in the process of infusing generative AI overviews into Search and is seeing improving engagement metrics and higher levels of user satisfaction," Devitt said.
Google's AI capex question not settled
"Monetization opportunities within generative AI results are a potential catalyst for the Search business in the coming quarters and years, and we remain optimistic as the company continues to prove its ability to manage through this period of transition," he added.
Other Wall Street price target changes include Morgan Stanley analyst Brian Nowak, who clipped $5 from his objective to take it to $205 per share, and Wells Fargo analyst Ken Gawrelski, who lifted his by $3 to $190 per share.
UBS analyst Stephen Ju, however, argued that while Google's AI spending ramp is already driving better-than-expected results in search, "the benefits it is seeing in GCP on AI productization still seem difficult to discern."
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"One of the biggest questions we have been fielding across our coverage has been when the ROIC from the incremental AI-driven CapEx will arrive, and we believe we have at least a partial answer, especially as it pertains to what Google is seeing in its own consumer-facing businesses," Ju said.
"So as far as we are concerned, the (return on invested capital) debate remains only partially resolved, especially as we are now contemplating what is a higher CapEx estimate for 2025 and 2026 vs prior," said Ju, who nonetheless lifted his price target by $4, to $204 per share.
Alphabet shares were marked 4.1% lower in premarket trading to indicate an opening bell price of $176.09 each, a move that would still leave the stock nearly 25% higher for the year.
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