Forget the Capex Fears: Why Alphabet and Amazon Are Must-Buys
Key Points
Amazon is seeing paybacks on its server investments in less than three years.
Alphabet is seeing a payback in less than two years, and even quicker with its own chips.
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Cloud providers have started to peel back the onion on their cloud computing economics, and it's now easy to see why these companies are pouring money into AI infrastructure. Demand for their services continues to outstrip capacity, while they are getting very strong returns on their investments with quick payback periods.
While Wall Street has feared this massive capital expenditure (capex), it should, in fact, be celebrating it. Let's look at why Amazon (NASDAQ: AMZN) and Alphabet (NASDAQ: GOOGL) (NASDAQ: GOOG) both look like great buys here.
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Amazon
Amazon was the first company to discuss its cloud economics, saying that it was getting to breakeven on its server and networking equipment investments in less than three years. Meanwhile, its AI capacity is contracted out for at least five years, and its servers have useful lives of at least five to six years. It added that it is also finding ways to extend the useful lives of its servers and get to breakeven more quickly. It tends to get five to six generations of server economics in its data centers, which last more than 30 years, so the economics actually get better over time with fewer upfront costs.
The tech giant plans to spend about $220 billion on capex this year and said that will still not meet the current demand it is seeing. It also expects to remain capacity-constrained in 2027 and said demand for 2028 is already massive. Its current backlog sits at $496 billion after more than doubling year over year. Meanwhile, the company believes AWS could become a $1 trillion business in the coming years. Amazon's economics also likely get better as it starts to use more of its custom chips.
In addition to its strong cloud business, Amazon also remains the leader in e-commerce. This business continues to hum along with solid revenue growth, although what is most impressive is the operating leverage this business is seeing from its investments in robots, AI, and digital marketing. This could be seen last quarter when its North America e-commerce revenue rose 16%, while its segment operating income climbed 21% to $7.5 billion.
With its AWS business booming and strong continued e-commerce growth, Amazon is a stock to own for the long haul.
Alphabet
Alphabet also recently revealed its cloud economics at an investment conference earlier this month. The company said it was getting a payback on its server investments in less than two years, and half that when using its custom Tensor Processing Units (TPUs). It, too, noted that its contracts are typically five years.
The company's biggest advantage is its TPUs, and it said its custom AI accelerator business is twice the size of the next largest hyperscaler. It also has its own Arm-based central processing units (CPUs). It said all this gives it "2.7 times better price performance for training, 80% better price performance for inference, [and] 30% better price performance for CPUs." On top of that, it has its own frontier model, Gemini, which it said is seeing strong growth with both large and small companies. It noted that because it can optimize the entire AI stack, it can offer its customers 2 times better inference per dollar, which is a big advantage.
Alphabet plans to spend up to $205 billion in capex this year and has said it expects to significantly increase that next year. Meanwhile, its backlog stood at $514 billion, including TPU system sales.
In addition to its rapidly growing cloud business, Alphabet's core search business is also benefiting from it incorporating its Gemini models to include features like AI Overviews and AI Mode. This is helping drive query growth, and its strong ad network helps it monetize consumer AI better than competitors.
Alphabet's TPUs and Gemini models give it great cloud economics, and as the most complete AI player, the stock looks like a long-term winner.
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Geoffrey Seiler has positions in Alphabet and Amazon. The Motley Fool has positions in and recommends Alphabet, Amazon, and Arm Holdings. The Motley Fool has a disclosure policy.
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