Sales up, shares down: Why cash flow now matters more than earnings

Shares of Alphabet, Google's parent company, and Tesla tumbled 7.1 percent and 14.5 percent, respectively, immediately after their earnings releases, even as both companies reported higher sales. With AI spending surging and international oil prices and US Treasury yields also rising, investors are applying a far stricter standard to technology stocks.

The common factor dragging down both share prices was profitability and cash flow. Alphabet's cloud business grew rapidly, but capital expenditure (capex) exceeded operating cash flow. Tesla posted a record second-quarter vehicle delivery figure yet saw operating profit fall 57 percent. The selloffs reflect growing investor doubt about when AI investment will translate into actual returns.

On Thursday, Alphabet's share price tumbled 7.1 percent on the Nasdaq. Second-quarter results released after the market close that day showed sales of $119.8 billion, up 24 percent from a year earlier. Google Cloud revenue rose 82 percent to $24.8 billion.

Despite the solid top-line numbers, the share price fell because of a heavier-than-expected investment burden. Alphabet's second-quarter capex reached $44.9 billion, up 25.8 percent from the previous quarter. With capex exceeding cash generated from operations, free cash flow swung to a deficit of $5.9 billion.

There is little sign that investment spending will ease anytime soon. Alphabet raised its full-year capex guidance to between $195 billion and $205 billion, up from the previous range of $180 billion to $190 billion, citing plans to expand spending on servers, data centers and network equipment to meet demand for AI and cloud services.

Google Cloud's order backlog has grown to $514 billion. However, the company plans to continue using third-party facilities until its own data centers are completed, which could add to near-term costs. Alphabet also warned that capex next year will rise significantly above this year's level, with depreciation and data center operating costs also set to increase.

US electric vehicle maker Tesla. [Reuters]

Tesla's shares fell even more sharply because weak profits compounded the investment concerns. Tesla fell 14.52 percent on the Nasdaq on Thursday. Second-quarter results released that day showed sales of $28.2 billion, up 26 percent from a year earlier, while vehicle deliveries rose 25 percent to 480,000 units — a record for any second quarter.

However, adjusted earnings per share came in at $0.33, well below the market consensus of $0.51 compiled by financial data firm LSEG. Operating profit fell 57 percent year-on-year, and the operating margin was just 1.4 percent. Lower average vehicle selling prices, higher research and development costs, and a decline in regulatory credit sales all weighed on profitability.

Tesla also saw capex outpace operating cash flow. Second-quarter capex reached $5.8 billion, up 142 percent from a year earlier, and free cash flow posted a deficit of $1.1 billion.

The cash burden could grow further. Tesla plans to invest more than $25 billion this year in autonomous driving, robotaxi and humanoid robot projects — roughly three times what it spent last year. With the core automotive business becoming less profitable and future-focused spending surging, the central question for investors is when those bets will pay off.

Ryan Lee, senior vice president of products and strategy at Direxion, said the "core concern is monetization" regarding Tesla's results, adding that "the key question is when the returns on investment will begin to support the company's valuation."

Broader market conditions on Thursday also amplified the selloff in technology stocks. As military tensions escalated in the Middle East, Brent crude futures closed above $100 a barrel for the first time since last May. Fears of a renewed rise in inflation pushed the yield on the 10-year US Treasury note to its highest level since early 2025.

Rising Treasury yields are particularly damaging for technology stocks, whose share prices already reflect expectations of future growth. Higher rates reduce the present value of earnings companies are expected to generate down the road. With cash flow already deteriorating due to rising investment costs, the discount rate has risen at the same time.

Matt Miskin, co-chief investment strategist at Manulife John Hancock Investments, said "overall the earnings numbers are great, but there are factors pulling share prices down across multiple companies," citing the rise in capex as an example. He added that "stocks are being sold off at the slightest sign of weakness."

kacew@heraldcorp.com