Amazon.com, Inc. (NASDAQ:AMZN) and Alphabet Inc. (NASDAQ:GOOGL) have reached such a point in their AI investment cycle where their cloud divisions are becoming more profitable, just as the companies are spending so much on infrastructure that cash flow looks considerably less impressive.
The stocks, meanwhile, are priced remarkably alike. Yahoo Finance’s latest available valuation data puts Amazon at 23.64 times forward earnings and Alphabet at 22.83 times. That small premium for Amazon raises a better question than which company has the bigger cloud business: which company is getting more earnings from the money it is putting to work?
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Bull Case
Amazon has the larger cloud operation. The company reported that AWS generated $42.2 billion in second-quarter sales, up 37% year-over-year, marking its fastest growth in 18 quarters according to management. Operating income climbed to $16.6 billion from $10.2 billion a year earlier. AWS supplied a significant chunk of Amazon’s total operating profit despite accounting for only 21% of sales. That is why the cloud division warrants more attention than its relatively modest share of consolidated revenue suggests. In other news, an ex-Google researcher said AI could “Kill Us All”. Should Alphabet investors care? Read here.
But Alphabet Inc. (NASDAQ:GOOGL) is making that comparison less comfortable for Amazon. Google Cloud revenue jumped 82% to $24.8 billion, and operating income rose from $2.8 billion to $8.8 billion. AWS remained substantially larger and more profitable in absolute dollars, but Google Cloud’s faster growth and widening margin give investors a reason to reassess the gap between the two businesses.
The companies’ other operations make the valuation comparison even less straightforward. Amazon’s North American retail segment earned $9.1 billion in operating income, up from $7.5 billion, while its advertising business grew 26% year-over-year, according to management. Which other big name stocks does the financial media favor? Access our complete list here for free.
Alphabet’s Google Search and other revenue rose 17% to $63.3 billion. Search remains a substantial source of revenue alongside Cloud, and Alphabet’s consolidated operating income increased 30% to $40.8 billion. That combination arguably gives Alphabet more than one established source of operating profits while its cloud business scales. We also shortlisted the best healthcare stocks to buy according to hedge funds. Check out the complete list here to make an informed decision.
Bear Case
The problem is what those profits cost to sustain. Amazon.com, Inc. (NASDAQ:AMZN) reported negative $7.6 billion in free cash flow for the twelve months ended June 30, compared with positive $18.2 billion a year earlier. The company attributed the change primarily to increased purchases of property and equipment, largely reflecting AI investments. AWS’s strong operating margin therefore does not mean Amazon as a whole is currently converting its expansion into surplus cash. Employment scrutiny may be becoming another risk for Amazon. Read more extensively here.
Alphabet Inc. (NASDAQ:GOOGL) faces much the same tension, on an even starker quarterly basis. It spent $44.9 billion on property and equipment in the June quarter against $39.1 billion in net cash provided by operating activities, leaving approximately $5.85 billion in negative free cash flow. Its cloud operating profits are genuine, but building the capacity to support further growth is consuming cash faster than operations generated it that quarter.
Neither company’s headline net income should settle this debate. Amazon’s $62.6 billion quarterly net income included $53.4 billion in pretax non-operating income, primarily associated with Anthropic investments. Alphabet likewise recorded $98 billion in net other income, principally unrealized gains on its equity securities. Those figures can overwhelm the operating picture without telling investors whether cloud infrastructure is earning an adequate return.
Conclusion
Amazon’s modest forward valuation premium is not obviously explained by AWS’s lead in absolute profits alone. Alphabet’s Cloud business is narrowing that operating gap while Search continues to deliver substantial revenue, and yet neither deserves a free pass on capital spending. The eventual valuation case for both depends on retaining more cash from each additional dollar of demand, which is, no doubt, less glamorous than AI revenue growth.
While we acknowledge the risk and potential of GOOGL and AMZN as an investment, our conviction lies in the belief that some AI stocks hold greater promise for delivering higher returns and doing so within a shorter time frame. If you are looking for an AI stock that is more promising than GOOGL and AMZN and that has 10,000% upside potential, check out our report about this cheapest AI stock.
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This article is originally published at Insider Monkey.
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