Alphabet lost just over $500bn (£374bn) in value on Thursday, and the reason is worth sitting with. Investors were not reacting to a collapse. Total revenue grew 25% to $127.6bn, and Google Cloud revenue rose 103% to almost $31bn. The problem is what sits underneath those figures, and what the company is willing to spend to chase the next wave.
The clearest warning sign is in the search business. Google's search engine now defaults to AI summaries of a person's query, and that hit the number of advertisements the company was able to sell during the quarter. Ads alongside search results make up the vast majority of Alphabet's business. When the core product changes in a way that reduces ad inventory, the company is cannibalising the thing that funds everything else. Tracy Woo, a principal analyst at Forrester, put it plainly: the results "highlights the challenge of funding massive AI investments while maintaining the strength of established businesses."
The cash numbers make the same point more starkly. Profits fell by a considerable 25% during the quarter, and Alphabet posted negative free cash flow of more than $9bn, its second such result in its history as a public company. That is almost twice the cash loss it showed just three months earlier. Free cash flow is what remains after a company pays for operations and investments, so Alphabet is now spending more than it brings in, and that spending is almost entirely dedicated to AI.
Google's chief business officer, Phillip Schindler, said on Wednesday that he felt "very good about our trajectory" with an AI-focused search engine. Investors clearly did not share that confidence on Thursday, when the stock fell almost 13%, its second lowest showing this year. Microsoft and Amazon are making similar commitments, so this is not a Google-only problem, but Google is the company whose existing profits are most directly at risk.
My view is that the market is right to demand more evidence before rewarding this strategy. Spending heavily on AI can be a sound long-term decision, but not when it erodes the revenue stream that pays for it and the cash flow is turning negative. Alphabet should show investors a clear path where AI monetisation replaces lost search advertising, with numbers attached, rather than asking them to trust the trajectory.