Alphabet and Tesla's AI capital expenditures raise investor concerns

Core Points

-The Nasdaq index plunged more than 2.5% on Thursday, led by Alphabet and Tesla

-Google's parent company Alphabet experienced negative quarterly free cash flow for the first time in history, with capital expenditures reaching US$44.9 billion in the second quarter

-Tesla's share price plunged 13.5%. Dragged down by lower-than-expected profit margins and US$5.8 billion in quarterly capital expenditures

-Large technology stocks such as Amazon, Meta, and Microsoft all experienced significant declines

-Industry experts warned that by 2027, the combined capital expenditures of the five major technology giants may exceed their combined free cash flow

On Thursday, Alphabet and Tesla released quarterly earnings reports that triggered violent shocks in financial markets. The capital expenditure data disclosed by the two technology giants completely outweighed their free cash flow generation capabilities, causing investors to question whether artificial intelligence infrastructure investment can deliver returns in a short enough period of time to justify its high costs. Sex?

The Nasdaq Composite Index plunged 2.8% to close at around 24975 points. The S & P 500 fell 1.5%, and the Dow Jones Industrial Average fell 1.2%.

Nasdaq Composite Index (^IXIC)

Analysis of earnings data

Alphabet's second-quarter revenue reached $119.8 billion, exceeding analysts 'expectations of $116.9 billion. Its Google Cloud business performed well, with revenue of US$24.8 billion, a year-on-year increase of 82%. However, what alarmed Wall Street was capital expenditures: it reached $44.9 billion in just three months, doubling from the same period last year. This huge expenditure fully covered $39.1 billion in operating cash flow, putting the company in a negative free cash flow area for the first time in its history. Management raised its full-year capital expenditure forecast to US$195 - 205 billion from the previous US$180 - 190 billion, while hinting that spending levels will rise further in 2027. CEO Sandar Pichai defended the expenditures, saying AI investments are "redefining the possibilities of every aspect of our business." But investors weren't buying it, and Alphabet's shares fell more than 7% on Thursday.

Tesla's financial report also showed a similar situation. The electric vehicle maker delivered 480126 vehicles, exceeding expectations, but the gross profit margin of its automotive business was only 16.3%, well below analysts 'expectations of 18.04%. Capital expenditures soared to $5.8 billion, an increase of 142%, as the company invested resources in self-driving taxi development and artificial intelligence projects. CEO Elon Musk told analysts he believed the investments would deliver substantial returns. The market responded with a 13.5% drop in stock prices.

The technology sector weakened broadly

Negative sentiment quickly spread to other large technology stocks. Amazon shares fell nearly 5%, Meta fell nearly 4%, and Microsoft fell more than 2%. Long before these latest earnings reports were released, the Philadelphia Semiconductor Index had fallen more than 20% from its high at the end of June.

Reuters research shows that the combined capital expenditures of five companies-Microsoft, Alphabet, Amazon, Meta and Oracle-may exceed their combined free cash flow by 2027. These companies plan to spend $1.57 on capital expenditures for every additional $1 of operating cash flow generated between 2025 and 2027. This financial equation can be maintained when these companies operate mainly on software business models with high profit margins and low physical infrastructure requirements. Artificial intelligence is fundamentally changing this pattern.

Keith Lerner, chief investment officer of Truist, said the current sell-off was more like a sector rotation than a full withdrawal from the market, noting that the industrial, energy and healthcare sectors were relatively strong. "The bull market still deserves credit, but it strengthens the view we have had over the past month that the market is entering a period of increased volatility," Lerner said.

Market participants are closely watching follow-up reports from Meta and Microsoft, both scheduled to release earnings on July 29, and Amazon, which releases earnings on July 31. These earnings results will determine whether this week's weakness in technology stocks is an isolated response or the beginning of a fundamental AI-driven revaluation of companies.