Will Google’s $200 Billion AI Bet Pay Off? History Says It Will.
Google parent Alphabet (GOOG +2.33%) (GOOGL +2.13%) reported blowout second-quarter results, yet the stock fell after its July 22 report.
The culprit for the sell-off was likely the large increase in Alphabet’s capital expenditures to build out artificial intelligence infrastructure. Management raised its 2026 spending target to $195 billion to $205 billion, up from prior guidance of $180 billion to $190 billion.
Alphabet’s free cash flow had already turned negative to ($5.9 billion) in the second quarter, the first negative free cash flow quarter in the company’s history. With the increased spending guidance, Alphabet’s free cash flow will likely remain negative for the year.
Image source: Alphabet.
Negative cash flow is a new development for Alphabet, making investors understandably nervous. The big question is, will all that spending pay off?
Fortunately, Alphabet’s short-term and long-term history suggests it will — in spades.
Today’s Change
(2.33%) $7.45
Current Price
$326.54
Key Data Points
Market Cap
Day’s Range
$324.33 – $330.07
52wk Range
$188.70 – $404.47
Volume
578.5K
Avg Vol
22.6M
Gross Margin
60.94%
Dividend Yield
0.26%
Return on capital remains high
By virtue of its near-monopoly on Search and profitable YouTube franchise, Alphabet has maintained a high return on invested capital throughout its corporate life. But with the aggressive build-out of generative and agentic AI infrastructure, the question is whether that will remain the case.
Fortunately, a quick look at the company’s recent numbers suggests it will.
Investors should keep in mind that data centers and chips bought today will translate into growth in future periods. In the second quarter, Alphabet’s Google Services, including Search and YouTube, grew operating earnings by about $6.5 billion, or 19.6%. Meanwhile, the Google Cloud unit’s profits exploded by $6 billion, up 212% year over year. Alphabet-level activities, which mainly consist of artificial intelligence research and development, grew by about 71.7%, or $2.4 billion.
That’s about a $10.1 billion net increase in quarterly operating income attributable to past capital expenditures, or about $40.4 billion annualized. After taxes, investors can assume a $32 billion earnings growth impact from past capital expenditures.
Let’s also assume there is a six-month gap between capital expenditures and the revenue and earnings that flow from that spending, on average. So, we’ll assume second-quarter 2026 earnings growth was driven by capital invested in 2025.
In 2025, Alphabet invested $91 billion against roughly $21 billion in depreciation. So, let’s assume that $21 billion was for “maintenance” capital expenditures to maintain 2025’s revenue and earnings base. That leaves $70 billion in “growth” capital spending, mostly toward the AI-related growth we saw in the second quarter.
Taking the $32 billion in incremental earnings on $70 billion in growth capital spending amounts to a 45.7% return on invested capital. That’s a huge number; the average company’s return on invested capital is roughly 10% today, according to data from NYU Stern valuation professor Aswath Damodaran.
A massive payoff in the 2030s?
Warren Buffett stated in his 1992 letter to shareholders that:
Leaving aside the question of price, the best business to own is one that, over an extended period, can employ large amounts of incremental capital at very high rates of return. The worst business to own is one that must, or will, do the opposite — that is, consistently employ ever-greater amounts of capital at very low rates of return.
Alphabet is spending a tremendous amount of capital now, but high recent returns on that spending suggest Alphabet’s big AI bet is paying off today. If this continues, Alphabet will create significant business value in the AI era, making this pullback a great buying opportunity for long-term investors.
