A busy round of big tech earnings calls starting on Tuesday night raises a critical question: Is the massive spending on generative artificial intelligence generating returns that justify the investment? Last week, Club-holding Alphabet's second-quarter report (which featured heavy capital expenditures and guidance that it will continue) reignited the debate over the near-term impact of AI on profits and the timeline before we see a significant financial upswing. The notion that Google's parent company is spending too much has sent its shares lower, setting the tone for other mega-cap tech companies announcing earnings this week. Microsoft opens the earnings season on Tuesday night, followed by Instagram owner Meta Platforms on Wednesday and Amazon and Apple on Thursday. This week's battle of tech earnings comes against the backdrop of July's so-called “Great Rotation,” which has seen investments in small caps and other market segments that lagged behind AI winners. Club is firmly in the camp that AI efforts will pay off over time. “These companies need to maintain their technological leadership, so the spending is worth it right now,” said Jeff Marks, director of portfolio analysis at Club. “Any investment that takes risk puts their future at risk,” he added. Still, it wouldn't be surprising to see a negative reaction on Wall Street this week if Alphabet's peers publicly disclosed increased AI-related expenses without a significant profit overhaul. In other words, increased spending is harder to stomach in a quarter that isn't a breakout performer. Jim also wrote on Sunday that giving management a rationale for spending is another way to help “ease the pain.” Alphabet's second-quarter capital expenditures were $13.2 billion, up 91% year over year and up quarter over quarter from $12 billion in the first quarter. The bulk of the funding is directed toward AI infrastructure, such as servers and data centers. On the earnings call, executives maintained their previous guidance that capital expenditures for the remaining quarters of the year will be equal to or higher than first-quarter levels. “As we navigate this curve, the risks of underinvestment are much greater than the risks of overinvestment,” Alphabet CEO Sundar Pichai said on a conference call. The comment was in response to a question about whether the company could have an excess of AI computing capacity in the coming years if current spending rates continue. A shortage of AI computing resources has been an industry issue since the launch of ChatGPT in late 2022 sparked the generative AI boom. According to estimates compiled by FactSet, Alphabet's annual capital expenditure spending is expected to be close to $50 billion. That's significantly higher than the $31.5 billion and $32.3 billion in 2022 and 2023, respectively. Alphabet's capital expenditures reaching or exceeding $50 billion “are likely to raise concerns” about its 2025 free cash flow and earnings per share estimates, KeyBanc Capital Markets said in a research note after the company's earnings release on July 23. The analysts continued that “capital intensity could hinder free cash flow growth,” but added that “it's hard to be too critical of Alphabet's capital expenditures, given the company's track record of making money with AI.” KeyBanc is right to defend the spending, because Alphabet's quarter shows that its bets are already paying off. Not only did its cloud-computing division, Google Cloud, post 29% revenue growth, but management noted that its newly launched AI overview is driving increased engagement in its flagship search engine business. While these details weren't enough to allay concerns about overspending, we felt they were encouraging and supportive of our multiyear optimism about AI. For companies reporting earnings soon, particularly Microsoft, Meta Platforms and Amazon, we expect executives to provide similar updates on how AI is already impacting their financials, as well as expectations for future benefits. Apple, meanwhile, is in a different camp, with much of the focus on upcoming iPhone launches and management's expectations about how AI features will drive demand. Meanwhile, in a paper published Monday, Apple said it used Alphabet's custom chips to train its AI models. Investor concerns about AI spending aren't entirely new. On Meta's first-quarter earnings call on April 24, management raised its 2024 capital expenditures outlook and said it expects year-over-year increases in 2025 to support AI research and development. The next day, the company's shares fell nearly 11% on concerns about overspending. But by early June, the stock had recouped all of those losses, in part due to the realization that Meta could benefit from AI through improved user engagement and advertising efficiency in its social media apps. Not everyone on Wall Street is on board with our belief that AI investments are worthwhile. And that skepticism underpins why some investors sold Alphabet after the quarter and why we're seeing negative views on Microsoft, Meta and Amazon this week. “The AI world has been too complacent in assuming that the cost of AI will fall over time,” Jim Covello, head of global equity research at Goldman Sachs, wrote in a client note in late June. “While the question of whether AI technology will deliver on the promises that many people expect today is certainly debatable, what is less debatable is that AI technology is so expensive that to justify its cost, it must be able to solve complex problems, which is what it was not designed for,” Covello argued. Meanwhile, some Wall Street AI optimists are expecting this week's report to cover the big picture. Wedbush Securities acknowledged that AI-driven capital spending will accelerate across industries, but the firm argued that the announcement “will ultimately prove to investors that the path to AI monetization is on track to see Street numbers rise in 2024/2025.” (Jim Cramer's Charitable Trust is long GOOGL, META, AMZN, AAPL, MSFT. See the full list of stocks here.) Subscribers to Jim Cramer's CNBC Investment Club receive trade alerts before Jim makes the trade. Jim waits 45 minutes after sending the trade alert before buying or selling shares in the Charitable Trust's portfolio. If Jim talks about a stock on CNBC television, Jim will wait 72 hours after issuing a trade alert before executing the trade. The above Investment Club information is subject to our Terms of Use and Privacy Policy, as well as our Disclaimer. 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A busy slate of big tech earnings reports starting Tuesday night raises a key question: Is the massive spending on generative artificial intelligence generating returns that justify the investment?
