Alphabet Lost $500 Billion in Market Value. Should You Really Buy AI Stocks Now?

Alphabet (GOOG -0.07%) (GOOGL -0.30%) investors had reason to frown last week as the stock posted its worst trading day ever. The shares fell 13% in one session after certain key elements in the tech giant’s earnings report disappointed investors.

What happened? It all starts with artificial intelligence (AI). Alphabet is at the forefront of the AI movement, something that has led to soaring revenue quarter after quarter. But to make this happen, Alphabet had to greatly invest in an infrastructure build-out, and this spending isn’t over. Alphabet isn’t the only company in this situation; others operating in the cloud space also are investing hundreds of billions of dollars annually to get the job done. In fact, Alphabet, Amazon, Microsoft, and Meta Platforms aim to spend more than $700 billion this year alone on infrastructure expansion. Though these companies are generating growth from AI, investors worry it may not be enough given their spending levels.

Considering the full picture, following Alphabet’s loss of $500 billion in market value in one trading session, you might approach AI stocks with a bit of hesitance. Should you really buy AI stocks now? Let’s find out.

Alphabet’s biggest revenue driver

We’ll start by talking about the negative impact of this spending on Alphabet. You probably know this company best for Google Search, as it’s something many of us use daily. The Google platform is indeed the company’s biggest revenue driver — advertisers pay to promote across it, and that generates billions of dollars for Alphabet. In the recent quarter, Google ads accounted for 64% of the company’s total revenue.

But Alphabet also has a cloud computing business that’s growing in leaps and bounds, supercharged by demand for AI infrastructure and enterprise solutions. That business delivered a record 103% gain in revenue in the quarter to more than $30 billion. This is positive and offers investors reason to be optimistic, but as mentioned, to reach this level of growth, Alphabet poured investment into an infrastructure build-out.

As a result, capital spending has exploded higher, and this has hurt free cash flow — these two elements were the points of concern in the company’s earnings report. Alphabet kept its capex forecast for the year unchanged at $195 billion to $205 billion. As for free cash flow, it came in at negative $9 billion, missing analysts’ estimates of $2.7 billion.

All of this reawakened investors’ concerns that, though AI investment is driving growth, this growth still may not justify the spending levels of Alphabet and other tech players in this AI revolution.

AI companies are in a period of transition

Now, let’s return to our question: Should you really buy AI stocks right now? AI companies today may indeed be in a period of transition. Over the past couple of years, investors have been excited about the initial AI opportunity as hardware and services companies have offered chips and related products to customers. This resulted in enormous revenue growth and double- and triple-digit gains in stock prices. And this, prior to the major infrastructure ramp-up, didn’t involve today’s capex levels.

Today, we’re at a point where, to move forward along the AI path to fulfill demand and potentially generate more growth, tech giants must heavily invest. While this investment is unfolding, they will experience pressure. Amazon chief Andy Jassy told analysts during the company’s second-quarter call in July that this spending would continue to be a headwind for free cash flow as the build-out unfolds.

With some investors frowning on this spending, we could see more turbulence in terms of stock performance in the months to come. If you’re a very cautious investor, you might wait on the sidelines for this moment to at least partially pass. But for most investors, right now, as these stocks decline, it’s the perfect time to buy at a bargain price. The long-term AI story remains bright, with the technology’s ability to transform the way businesses operate in a positive way. And this means investors who include AI stocks in a well-diversified portfolio could score a major win over the long run.