Shares in Alphabet (GOOG +3.96%) rose by more than 4% in trading before 10 a.m. today in what looks like a kind of "flight to quality" in the AI-related sector. Here's why that could continue.
Why the market is questioning AI growth
Understandably, the market might get jittery about the AI/data center investing theme at some point. AI/Data center stocks have been running hot, and there's mounting speculation that a bubble could be forming in the sector.
NASDAQ: GOOG
Key Data Points
The gist of the argument is that hyperscalers, like Alphabet, are investing heavily in AI, and their returns on that investment may not quite turn out to be as strong as the market expects. The corollary is that a broad-based slowdown in spending will follow, taking AI-related stocks down with it.
In addition, there are some concerns, articulated by "Big Short" investor Michael Burry, that hyperscaler assumptions over the useful life of network equipment and servers will prove shorter than they currently anticipate, implying the returns on capital investment might disappoint.
Why Alphabet is well placed
While those concerns need consideration, it's also worth noting that Alphabet's mammoth cash flows (which primarily originate from Google Advertising) mean it can easily fund its own AI investments.
GOOG Free Cash Flow data by YCharts
Second, AI and data center investments aren't things best suited to measuring the return on investment over a short-term period. For example, Google Cloud reported a $3 billion loss on revenue of $26.3 billion in 2022, only to turn profitable and reach $8.6 billion in operating income on $41 billion in revenue in the first nine months of 2023.
Image source: Alphabet.
The point being that the business model of cloud computing services involves generating a powerful stream of recurring revenue from customers in its ecosystem. That can't be easily measured in the early stages of an AI investment cycle, as some are attempting to do now.
