Alphabet Just Delivered 82% Cloud Growth. Why It Wasn't Enough

Investors were eagerly anticipating Alphabet's (NASDAQ: GOOG) (NASDAQ: GOOGL) second-quarter earnings report on Wednesday, and the numbers did not disappoint.

Alphabet nearly doubled revenue in the key cloud segment, with Google Cloud revenue up 82% to $24.8 billion. Even more impressive was operating income in the cloud segment, which more than tripled to $8.8 billion, thanks to the boom in AI infrastructure spending.

Alphabet's overall numbers were strong as well, as revenue jumped 24% to $119.8 billion, well ahead of the consensus at $117 billion.

Operating margin also expanded from 32% to 34%, translating into $40.8 billion in operating income. Despite those strong results, Alphabet stock was down after hours, losing as much as 5% before clawing back some of those losses.

Image source: Google.

Alphabet's free cash flow goes negative

While the numbers on the income statement were phenomenal, investors seem more concerned with the company's bulging capital expenditures.

Management had made it clear to investors that it was ramping up capex spending to capitalize on the opportunity in AI, and it raised its capex forecast again in the quarter, hiking it by $15 billion to $195 billion-$205 billion.

In the second quarter, the company also reported negative free cash flow for the first time ever as a publicly traded company. It brought in $39.1 billion in operating cash flow, but spent $44.9 billion on capital expenditures, giving it negative free cash flow of $5.8 billion.

After the increase in its capex forecast, the company is on track to spend around $120 billion in capex in the second half of the year, meaning that investors should expect the company to continue to report negative free cash flow.

Should investors be worried?

On a macro-level, the market seems suspicious about the massive capex spending from the four hyperscalers, Alphabet, Microsoft, Amazon, and Meta Platforms, which is likely to approach $800 billion this year.

That assumes a lot of value creation from AI in the future.

However, on an individual basis, Alphabet can easily manage a free cash outflow. The company has more than $240 billion in cash and marketable securities, and it has arguably more applications for AI spending than any other company, considering its Google Cloud business, Gemini and other generative AI investments, and its core advertising business.

While investors might see the move as risky, it should pay off over the long term. In the meantime, investors should be satisfied with 24% revenue growth, booming cloud growth, and its expanding operating margins.

Jeremy Bowman has positions in Amazon and Meta Platforms. The Motley Fool has positions in and recommends Alphabet, Amazon, Meta Platforms, and Microsoft. The Motley Fool has a disclosure policy.