Google's searches are growing at the fastest pace in five years. Much of that comes from AI Mode, its new chatbot-style search. The catch is that AI Mode answers earn less from ads than a regular search does. Alphabet (GOOGL), Google's parent, told investors so after the close on Wednesday, Oct. 28. On Thursday, Oct. 29, the stock fell 12.64%, its worst day on record.
The quarter looked fine from a distance. Sales grew 25% to $127.6 billion. The cloud business beat, at $30.7 billion. But the services unit, which holds search, brought in $96.3 billion. Wall Street wanted $98.5 billion. Search revenue grew 12% from a year earlier. It grew 17% the quarter before and 19% the quarter before that. The trend points one way.
The bigger shock was cash. Alphabet's capital spending, the money it puts into data centers and equipment, hit $51.4 billion in the quarter. It was $44.9 billion the quarter before. Free cash flow is the money left after paying for all that building. It was already below zero, and it sank to negative $9.1 billion, far worse than analysts expected. The finance chief, Anat Ashkenazi, said spending would rise "significantly" in 2027. Philipp Schindler, Google's chief business officer, said the company is only now putting more ads into AI Mode. Erin Woo reported the numbers for the Journal.
The case for the loser
The Journal's Asa Fitch argued Friday that markets aren't giving Alphabet enough credit. In his view, it owns every piece of the AI race. It builds a top AI model and its own chips, runs a fast-growing cloud and sells a giant ad business. No rival has the whole set, he wrote. At Wednesday's close, Microsoft (MSFT) traded at about 25 times its expected earnings. Alphabet traded at about 20. Alphabet also held $265 billion in cash and securities at the end of the quarter, more than any other big tech company. That cushion matters. Its capital spending is running about $200 billion this year, and analysts expect about $312 billion next year. Its operating margin, the share of sales left after running costs, still widened to 32%. Depreciation, the yearly cost of wearing out all that equipment, rose 49% to $8.4 billion. Fitch expects the heavy spending to keep free cash flow negative for some time.
Our read
This is an Investments/Risk story, IN04. A great business can still be a crowded stock, one that too many investors own for the same reason. For two years, investors forgave the AI spending because search threw off so much cash. This quarter search slowed while the cash flow sank deeper below zero. The forgiveness ended, and $499.8 billion of value left in a day. Alphabet is held at weight in 28 of our model books. Nothing was added. A cheaper price after a miss isn't a buy signal on its own. The $265 billion cash pile is why we aren't worried about the company's health. The stock's price is a separate question.
Here's the check for your own plan. Open your 401(k) or brokerage app this week and find your S&P 500 fund's top holdings. In most of these funds Alphabet shows up twice, as GOOGL and GOOG, its two share classes. Add the two lines together. Then add any Alphabet shares you own on your own or through a tech fund. That total is your real stake in Thursday's drop. You don't check the roof during the storm. You check it on a dry afternoon.