Alphabet’s Multiple Futures Now Cost Less to Own

After the market closed on Oct. 28, Alphabet (NASDAQ:GOOGL) reported that its cloud business had more than doubled its revenue in a year. In the same release, it showed that it had spent about $9 billion more cash than it brought in during the quarter. The stock fell over 10% at Thursday's open.

Rule Breakers recommended Alphabet on June 9, 2022, at a split-adjusted $113.75. Even after that drop, the stock has gained more than 150% from that price and remains comfortably ahead of the S&P 500. Across Motley Fool services, Team Rule Breakers and Team Hidden Gems have recommended it many times since.

The first of six Rule Breakers Principles is: Make Your Portfolio Reflect Your Best Vision for Our Future.

The idea is to own companies whose success would build the world you hope to see, and to lean optimistic about where that world is heading. Rule Breaker investors favor companies with multiple futures. Most large companies have only a couple of realistic paths ahead, while the best innovators may have a dozen or more. David Gardner has long pointed to Alphabet as the leading example, with Google's search profits paying for ventures from AI to self-driving cars.

Several Futures Arrived in One Quarter

Google Cloud brought in $30.7 billion in the quarter, up 103%, and its operating profit roughly tripled. Part of that growth came from selling Alphabet's custom AI chips, called TPUs, to outside customers, a relatively new line of business.

Alphabet said search queries grew at their fastest pace in five years. It also owns stakes in other fast-growing companies, and swings in their value have moved its reported profits by tens of billions of dollars this year.

Google Cloud, long the third-place player in cloud computing, now accounts for nearly a quarter of Alphabet's revenue.

The Bill for All Those Futures

Alphabet expects to spend $195 billion to $205 billion on capital projects this year, mostly data centers and chips, and management said that figure will rise significantly in 2027. Spending at that pace pushed free cash flow negative for the quarter. Alphabet's long-term debt has climbed to about $125 billion, nearly six times what it was a year earlier.

Reported earnings per share fell about 26%, though most of that came from paper losses on its equity stakes. Operating income still grew 30%.

When the Engine Slows

Search, the business that has paid for everything else, is losing speed. Google Services revenue grew 11%, down from 15% the previous quarter, and search revenue came in short of expectations. Search profits funded Alphabet's experiments for two decades, and borrowed money now covers part of that bill.

If AI demand cools before the new data centers pay off, the debt would stay on the books, and Alphabet's balance sheet would look a lot more like an ordinary company's.

Where That Leaves Alphabet's Shareholders

Owning Alphabet now means believing that cloud and AI chips will earn back their enormous cost, and that search slowed in one quarter without losing its grip on how people find things. It also means accepting a period in which debt covers part of what cash once paid for on its own. An investor who sees AI spending as a bubble will find that trade unappealing.

Alphabet's customers appear to be betting the other way, with Google Cloud's backlog of signed contracts above half a trillion dollars. Investors who share that view can buy those futures today for about 10% less than before the report.

The Rule Breakers Team has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet. The Motley Fool has a disclosure policy.