Something Big Just Changed for Google Stock

Something pretty significant has just changed for Alphabet. A US appeals court has allowed more than 3,000 lawsuits involving companies including Google to continue over allegations that social media platforms were deliberately designed to be addictive to young users. And understandably, when you see a headline involving Google, thousands of lawsuits, and potentially years of litigation, it's very easy to immediately ask whether this should change the investment case. But I actually think that is the wrong question because something much bigger is already happening underneath Alphabet's business. Google is making more money than ever before. While at exactly the same time, its free cash flow has suddenly been crashed by the enormous amount of money being poured into artificial intelligence. When we look at their latest quarter, they reached in fact near 120 billion of revenue, more than 40 billion of operating profit, search growing strongly, and Google Cloud accelerating at an extraordinary rate. This does not look like a broken company. But cash generation tells a completely different story. And that's why today I don't want to give you one price target for Google. I've built three completely different versions of Alphabet's future. In one scenario, the enormous AI investment fails to generate anything close to the returns the market expects. That gives me a valuation of just $167 per share. In my base case, I get around $323. And even in my most bullish case where Google executes extremely well, I only get around 393. With Google currently around $357, that creates a very interesting problem. Now, first up, we have the new legal development. The Ninth US Circuit Court of Appeals has rejected an attempt to stop this sprawling litigation before trial, meaning more than 3,000 lawsuits can continue moving forward. And these suits involve Meta, Google, TikTok, Snapchat, and other companies. And they've been brought by a mixture of individuals, school districts, municipalities, and states. And the allegations, as we can see, they center around whether platform features were intentionally engineered to increase addictive behavior among young users. And there's also an important distinction here. This is not a court finding that Google is liable. The appeals court, well, essentially what they're saying is the companies were attempting to appeal too early in the process. And a big part of the argument, well, it revolves around Section 230, which generally protects internet platforms from liability relating to user-generated content. The companies, well, they argued those protections should allow an immediate appeal. The panel, well, they disagreed. So, the underlying case, it will continue. And we can see the distinction matters because the claims, they're increasingly focused not simply on what users posted, but on how the products themselves were allegedly designed and operated. And we've already seen comparisons being drawn with big tobacco. Not because the financial consequences are remotely known yet, but because plaintiffs are attacking the design and incentive structure of these platforms. It makes this worth watching. And you've got features like infinite scroll, autoplay, and recommendation algorithms. They're increasingly becoming part of the legal debate. And given YouTube's importance aspect, this isn't something I'd completely dismiss. But equally, I wouldn't build a $4 trillion investment thesis around trying to predict the outcome of thousands of individual court cases. There are simply too many unknowns around dangers, appeals, settlements, and eventual regulation, which is why I think investors need to separate headline risk from valuation risk. The lawsuits, yeah, they may become expensive. They might lead to product changes. But they aren't currently the reason my valuation range goes from $167 to almost 400. The enormous range exists because of something happening inside Alphabet right now. Google is still growing. Google is still exceptionally profitable, but the relationship between profits, investment, and actual cash return to shareholders, well, that's changing dramatically. And you can see investors are starting to notice. Google has been weak recently, including a rough 5% drop in just the last few days. But, also, if we step back, it still remains positive year to date. So, today isn't a crash stock story. It's a story about whether today's valuation properly reflects what Alphabet has to spend to remain one of the winners in AI. And before we talk about spending, we have to establish something important. Alphabet's underlying business is extraordinary strong. Revenue in the latest quarter here reached nearly 120 billion, up 24%. Google search advertising alone produced 63 billion, growing around 17%. So, despite several years of people predicting that generative AI would immediately destroy traditional search, well, in fact, that simply hasn't happened yet. And look at the consistency. Search remains the enormous blue block underneath the business, but importantly, Alphabet is no longer relying on only one engine. YouTube subscriptions, devices, and cloud, they're all contributing meaningful revenue. I mean, even in advertising, Google remains an absolute machine. The search business continues to dwarf most stand-alone advertising businesses, while YouTube itself, that's become an enormous advertising platform. And profitability, well, it remains exceptional. We can see from Seeking Alpha they get an A+ overall grade, extremely strong EBIT margins, return on equity, and operating cash generation. And you'll also notice that growth isn't disappearing, either. Revenue growth is running around 20% both year on year and on a forward basis. EBITDA has grown strongly and forward earnings growth that remains substantial. I mean, their operating profit has gone from a few billion dollars a year in Alphabet's early history to well over 100 billion annually with estimates climbing materially higher. It's why I'm not comfortable with this simplistic argument that Google is somehow being destroyed. And then look at earnings per share, that's followed the same long-term trajectory. And historically, Google share price has followed those earnings higher. But there is one very important complication with the latest reported number. Net profit in the latest quarter was massively distorted by around 98 billion of investment gains. So, I wouldn't look at this 112 billion net income figure and assume that Alphabet suddenly created 112 billion of repeatable operating profit. It simply didn't. The chart here, in fact, demonstrates the problem beautifully. Net income, yes, that's exploded. Free cash flow hasn't. In the latest quarter, we saw net income that's up to around 112 billion, while the free cash flow is actually turned negative. And that is the number I'm much more interested in because ultimately for a DCF investor, the question isn't simply how impressive accounting earnings look. It's how much sustainable cash this company can generate after paying for the infrastructure required to ultimately protect their moat. And while historically, Alphabet was fantastic at this, annual free cash flow climbed from around 24 billion in 2017 to more than 70 billion by 2024 and 2025. Now, that relationship is being tested. And the biggest reason I'm not automatically bearish on all of this spending is Google Cloud. Quarterly cloud revenue has gone from less than 5 billion in 2021 to almost 25 billion in the latest quarter. And more importantly, the growth rate has re-accelerated dramatically. We can see Google Cloud growth reach around 82% year-over-year. And that's an extraordinary acceleration for a business already generating tens of billions in quarterly revenue. And against the other hyperscalers, Google's acceleration stands out. Azure remains strong, AWS has accelerated, but Google Cloud's reported growth rate has moved substantially ahead. It matters enormously when we're trying to decide whether this CAPEX is productive because cloud it isn't just generating revenue anymore. Operating income has moved from persistent losses to billions of dollars of quarterly profit. And this is perhaps one of my favorite charts in the entire episode. Google Cloud margins were deeply negative only a few years ago. Now we can see it in the low to mid 30% range. This changes what Google Cloud can become. It isn't merely a strategic expense designed to keep AWS and Microsoft honest anymore. It's increasingly becoming a highly profitable standalone economic engine and new annual recurring revenue added it has accelerated sharply as well. The latest quarter reach around 19 billion of ARR added. And incredibly that puts Google right alongside the amount of new ARR being added by AWS and Microsoft's cloud businesses in the latest period. It's a completely different competitive position from just several years ago. And then we have the backlog. Google's cloud backlog has reached around 514 billion. That's contracted businesses waiting to convert into future revenue. And you can see the rate of backlog has been enormous. This isn't simply management saying AI demand is strong. Customers are signing very large long-term commitments. We can see across AWS, Azure, and Google Cloud combined backlogs exploded. And Google has become a genuinely meaningful part of that contracted demand. And we can see some analysts, well, when they're looking at the share of major cloud revenue, they see it increasing for Google from 22% in 2026 to 28% by 2028. Obviously, it's an estimate, it's not a guarantee, but it illustrates what the bull case actually requires. And then you've also got potential upside from Alphabet's custom TPU infrastructure. We can see estimates here suggesting Google could potentially generate around a 25% gross margin selling external TPU capacity. Again, it's an estimate, but strategically it definitely matters. And if Google can lower the cost of delivering AI through its own silicon, then the economics of AI search, Gemini, and Cloud improve simultaneously. And suddenly, some of this gigantic infrastructure bill it starts looking much more productive. And Alphabet's also massively expanded long-term investments. So, we're not looking at a company standing still while the industry changes around it. It's deploying capital across multiple layers of the AI stack. And even as recently as the last few days, Google has reportedly been pursuing deals such as the 1 and 1/2 billion plus Mechanize transaction AI coding agents. So, the bullish argument is clear. Yes, Alphabet is spending extraordinary amounts, but Cloud is already providing evidence that some of this investment is beginning to monetize very quickly. The problem is though that money alone doesn't guarantee leadership. Google has also been dealing with a series of high-profile changes and departures inside its AI organization. And I don't think investors should dismiss this entirely. When you're competing against OpenAI, Anthropic, Meta, and some of the best funded startups in history, elite researchers, well, they become part of the moat. And Aidan Gomez knows this world extremely well. He previously worked at Google Brain and co-authored the landmark Attention Is All You Need paper. And I think his assessment of Google's leadership changes is exactly the right level of concern. >> Uh I think it's a it's a setback for sure. I mean, he's an extraordinary talent. The others that he brought with him like Sanjay and Oriol, again, just incredible names who have contributed so much to Google and DeepMind and the competitiveness of the organization. I would say uh Google's a big organization. That's part of the reason why I expect this group is leaving, but there are many, many capable individuals to fill uh those roles. So, I don't think we can read too much into the leadership change. >> That's exactly how I'd frame it. It's a genuine setback, but it's very different from saying Google suddenly doesn't have the talent or resources to compete. Because Google, they've got virtually every strategic resource you could want. Massive liquidity, its own compute stack, proprietary data distribution across billions of users, and one of the strongest balance sheets in technology. The bigger issue is whether all of those resources can be converted into economic returns. And that's where another comment stood out to me. Google has arguably been one of the most important AI research organizations in history. But inventing technology and monetizing technology, they're two completely different things. Listen to how Demis Hassabis described Google's own experience. >> Actually, you know, Google Google Brain specifically, the research division in Google and DeepMind as it was, sort of fairly independent. We kind of invented about 90% of the technologies that everybody's using today. You know, whether it's transform formers, of course, most famously the architecture behind all the LLMs or AlphaGo, you know, sort of introduced reinforcement learning at scale on a really hard problem. So, we've invented all this technology, but then maybe we were in hindsight we were a little bit slow to commercialize it and scale it. And you know, that's what OpenAI and others did very well. >> And that is basically the entire valuation debate in one sentence. Google can be brilliant at AI and Shells can still earn disappointing returns if the economics don't follow because ultimately cloud isn't the only asset we need to protect. Search is still the foundation of Alphabet, and search economics are what makes the AI transition uniquely difficult for Google. Google, well, they already own one of the most profitable monetization systems ever created. A user types something with commercial intent, Google understands the intent, advertisers compete for that attention, and Google gets paid. The challenge is that generative AI changes the user interface. Instead of 10 links and several advertisements, users increasingly receive a direct answer. That potentially changes clicks, ad inventory, compute costs, and monetization. And AI answers create another category of risk, as well, accuracy and trust. We have this example where researchers criticized Google's AI overview for admitting important context around the history of tobacco companies. Now, obviously, this doesn't destroy search, but it reminds us that replacing a traditional results page with generated answers it introduces new reputational, regulatory, and product quality risks. If an AI answer is wrong, or in fact incomplete, Google owns the answer in a way it didn't necessarily own the contents of every webpage appearing a traditional search. That creates a different type of responsibility. On the other hand, Google's latest search numbers are telling us something very important. Users have not suddenly disappeared. Search revenue is still growing strongly. In fact, in their latest quarter it produced around 63 billion of revenue, up 17%. So, anyone who says AI has already killed Google search simply isn't describing the numbers that we're seeing. And Alphabet as a whole is now producing more than a billion dollars of revenue per day, and we can see they're climbing dramatically over the next several years. That is based on analyst predictions. And then look at the underlying revenue and earnings trajectory, they remain exceptional. The bearish case, therefore, cannot simply be that search disappears. I don't think that's credible. The more credible bear case is search remains huge, but AI makes it more expensive to deliver, more difficult to monetize, and dramatically more capital intensive. And that's already starting to sharpen the cash flow statement, which brings us to the biggest issue in this entire episode, Google's quarterly CapEx roughly doubled from around 22.4 billion to 44.9. That is an extraordinary change in the economics of the business. We've got revenue surging, operating profits surging, cloud surging, and yet free cash flow fell below zero. That is a contradiction that we need to solve. And we can see that Alphabet's plan 2026 AI investment is sitting around 205 billion. Now, whether the eventual number lands precisely there, that's not the important part. The important part here is the scale. And Morgan Stanley's forecast, they believe Alphabet's CapEx will be around 202 billion 2026, rising even further in subsequent years. Now, they're forecasts, not certainties, but just look at that direction. Where, in fact, across the entire hyperscale group, the amount of capital being deployed has become so enormous that this chart compares it with the telecom infrastructure build out around the dot-com era. Does not automatically mean bubble, but that is extraordinary. And then you've got companies with increasingly supplementing internal cash generation with debt. We can see Alphabet is among the largest hyperscale issues since the AI build out accelerated. Now, yes, Alphabet still has a fortress financial position. The latest balance sheet snapshot, well, we can see enormous cash investments. So, this isn't a solvency problem, it's an opportunity cost problem, where every dollar spent on infrastructure is a dollar that doesn't currently show up as free cash flow, and these evaluations ultimately care about when and whether those dollars come back. And this comparison is striking. We can see for 2027 projections of free cash flow for hyperscalers, Microsoft or Alphabet around 57 billion of free cash flow, Google around 23 billion, Amazon around 20, and Meta around 11 billion. Now, consensus, they do expect a huge recovery later in the decade, and that's extremely important because the market isn't assuming depression last forever. It's assuming an eventual snapback, and this makes the expectation visually obvious. We're essentially standing in the trough. The bull case assumes the trough is temporary. The bear case assumes investors are underestimating how long it lasts. And interestingly, broader Wall Street is becoming more relaxed, not less relaxed about the spending. And maybe you can argue they're right. Maybe the market is correctly looking through this temporary cash flow collapse because the infrastructure being built today will generate enormous future revenue, and there is certainly evidence supporting that. Google's backlog is growing far faster than CapEx in some of these comparisons. So, the spending isn't occurring in a vacuum. Demand is following. We've also got cloud revenue growth, which is accelerating. This is exactly what you'd hope to see while you're investing this aggressively. And then you've also got margins which are simultaneously expanding. Again, that's very important evidence against the argument that every AI dollar is being incinerated. But look, at the same time, investors shouldn't confuse revenue growth with free cash flow. Eventually, the infrastructure has to generate more cash than it ultimately consumes, and that is exactly what my three valuations will be designed to test. Not whether AI is impressive, not whether Gemini is a good model, but what Alphabet ultimately earns on all this capital. And this is where things become slightly confusing. On one measure, Google's valuation gets an F grade relative to the wider technology sector. But look deeper, and the picture gets much more nuanced. We can see that the forward earnings multiple here sits around 17. Although historically Alphabet has traded at a materially high multiple, bear in mind though this in fact is being distorted by what we showed earlier in terms of the investment gains, which is wide increases in 2027 and then starts to fall. We can see in fact 2029 estimate pretty much the same as 2026. Where we can see this chart here, it does make the argument visually. Alphabet's revenue much higher for years while the valuation model is repeatedly compressed. The stock itself, well we can see sits at $357. It is below its recent high, but clearly nowhere near distressed territory. And if we look at drawdowns, well Google sits around 13% below its high. So again, we're not talking about buying a stock that the market has abandoned. And Wall Street, well they remain considerably more optimistic about the company with the average analyst target sitting at $428 in implying around 20% upside. The highest target in fact reaches around $515. And analysts, well as we can see from the summary, remain broadly positive. Seeking Alpha buy four out of five, Wall Street giving it a strong buy 4.6 out of five. And institutional capital hasn't dissipated either. So this isn't a contrarian everyone hates Google setup. Quite the opposite actually. There is still significant confidence in this company today. And that means my valuation has to answer a harder question. How much of Google's success is already reflected in $357? So now let's go through the three scenarios, same discount rate, same terminal growth framework, same sensitivity structure. The only thing I'm fundamentally changing is what happens to Alphabet's future cash generation. And let's start off with the bear case. And importantly, my bear case does not assume Google disappears. Search remains huge, cloud remains meaningful, YouTube remains valuable. I think assuming that search simply collapse would be far too extreme given what the actual business is currently doing. Instead, my bear case assumes the economics deteriorate, AI search requires more compute, CapEx stays structurally elevated, depreciation rises, and the incremental returns from that spending comes in far below today's optimistic expectations. That gives me free cash flow of 30 billion in 2026, 20 billion in 2027, 45 in 2028, 70 billion in 2029, and 90 billion by 2030. So, this isn't a company that's going bankrupt. It's a fantastic company discovering that the next generation of its product is dramatically more expensive to build and operate than the last generation. And then keeping my 12, 14, and 16% growth sensitivities unchanged, it reduces valuations of $158, $167 at the mid-rate, and $177 at the upper rate. So, the central value is therefore $167 per share against approximately $357 today. That would represent roughly 53% downside to the intrinsic value. And that's where the $170 number that you saw on the thumbnail comes from. It's not me saying that Google will fall to $170. It's what the business is worth if the economics of the AI cycle disappoints badly. And in essence, telling us today the company's trading at a 113% premium. And because cloud demand is already so strong, I don't think this is the most likely outcome. But given the unprecedented level of investment we're seeing, I absolutely think investors should understand what failure would look like. Now, my base case is much more constructive. Here, I'm assuming the current free cash flow collapse really is a temporary investment cycle. Cloud where it continues growing strongly, search successfully incorporates AI, YouTube remains healthy, and Google's AI infrastructure gradually begins producing enough incremental revenue to justify the spending and cloud margins continue expanding. Gemini improves engagement across the ecosystem and the economics of AI inference becomes more efficient over time. Where custom chips and efficiency improvements are important here because my base case requires Alphabet to stop getting progressively more capital intensive forever. Eventually, unit economics have to improve. Therefore, my base case free cash flow becomes 30 billion in 2026, 50 billion in 2027, 90 in 2028, 140 billion 2029, and by 2030, 180 billion. This is already a very substantial recovery. Remember Alphabet generated around 73 billion of free cash flow in 2025. I'm assuming it eventually reaches almost two and a half times that level. And at my same sensitivity assumptions, I get $305 at 12%, 323 at 14, and 342 at 16%. So, the number I actually care about is $323 per share. That's around 10% below the current market price. And this is where the video becomes much more interesting to me because I don't think these are bearish assumptions. I think this is a pretty strong outcome for Alphabet. Where we have search surviving, cloud growing enormously, AI monetization improving, free cash flow eventually reaching 180 billion. And even then, I still don't get enough value to justify $357. So, finally, let's make things go extremely well. This is my bull case. Google doesn't merely survive the AI transition, it wins it. Google Cloud continues taking share. We can see here GCP reaching roughly 28% becomes directionally correct. Enterprise AI demand continues exploding and the enormous backlog converts into revenue. New ARR keeps accelerating and Google turns today's infrastructure spending into a genuinely dominant AI cloud platform. Meanwhile, search monetization remains intact. AI gives users new ways to interact with Google rather than simply cannibalizing old searches. YouTube keeps growing, subscriptions expand, and TV using custom infrastructure lowers Google's cost structure. Google earns attractive margins from third-party AI workloads, and this return on this enormous CapEx program ultimately becomes obvious. And that gives me 30 billion of free cash flow 2026, 65 in 2027, 115 in 2028, 175 in 2029, and 220 billion by 2030. Under those assumptions, I get $371, $393, and $417 across the three sensitivity rates. My central bull value is therefore $393, only around 10% above today's share price. And that, more than anything else in this entire episode, is why I'm cautious at today's valuation. So, if we put all three outcomes together, at the bull case, we have 393, at the bear case, 167, and at the base case, 323. With the current price around $357, and Wall Street, where the average price target is above my bull case central valuation, doesn't automatically make Wall Street wrong, but it tells me expectations already quite high. And I want to be clear, I think Google is an exceptional business. Cloud might actually be becoming stronger, faster than almost anyone expected, and the margin expansion here is phenomenal. Search is also not dying. It's still growing at a rate that would be impressive for a company 1/10 of Alphabet's size. And Cloud is approaching around 25 billion of quarterly revenue and accelerating. There are very few companies on Earth with this combination of both scale and growth. But valuation ultimately doesn't ask whether a company is impressive. It asks what you're paying for the future cash that ultimately belongs to shareholders, and right now cash is being swallowed by an extraordinary investment cycle. So, for me, there are four things I want to watch from here: CapEx, free cash flow recovery, Google Cloud margins, and whether AI search monetization can remain as powerful as traditional search. And the lawsuits matter, the leadership change matters, and the AI competition matters, but none of those individually changes my view as much as the answer to that cash flow question. And around $357, I personally cannot call Alphabet cheap using my own base case assumption. I would need either a lower share price or evidence that the $180 billion 2030 free cash flow assumption is actually too conservative. And if Google continues producing cloud numbers like these, the bullish outcome could absolutely become more plausible. But right now the market is already pricing us considerably closer to that future than to my base case. So, while I remain extremely impressed by Alphabet the business, I'm simply much more selective about Alphabet the stock at this price. And that's an important distinction. But let me know below which scenario you think is closest to reality because where Google's free cash flow lands between now and 2030 will ultimately determine which of those worlds we're actually living in. And if you want to see the exact same setup but for Meta, well, that was released in our latest weekly article. We drop one every single week covering severely undervalued stocks as well as what's going on in the market. You can click below, sign up, read all of these straight away. More importantly, have a great day. I'll see you all on the next one.