AI Spending Erodes Free Cash Flow, US Tech Giants' Earnings Trigger Selloff

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Over the past two weeks, as a series of tech giants successively released earnings reports, what was originally thought to be able to bring some clear guidance to a stock market that had been wavering due to numerous risks—especially doubts about massive investment in artificial intelligence—did so.

After these performance figures were released, the outlook indeed became clearer, but unfortunately also much gloomier.

Although the earnings reports of the big AI spenders showed that the cloud computing business is still booming, investors were not buying it. Instead, they focused on the rising cost of data center construction, which is eroding free cash flow. This triggered a sharp selloff on Friday, expanding the October decline of the tech-heavy Nasdaq 100 Index to 6.7%, the worst monthly performance since the market's tariff panic in March 2025.

"This reflects that investors are becoming more selective, because I don't think every hyperscaler will be a winner in the future," said Anthony Saglimbene, chief market strategist at Ameriprise. "Ultimately it will all come down to how much companies are spending, how much return they can get, and how deep their moats are, so as to whether they can continue to achieve revenue growth."

Alphabet shares plunged 13% on Thursday, the largest single-day drop in history. Earlier, the Google parent reported disappointing sales in its core search business and negative free cash flow for a second consecutive quarter, something that had never happened since the company went public. Amazon's subsequent earnings report showed that its negative free cash flow was much worse than analysts expected, mainly due to increased capital expenditures and e-commerce business growth slowing to the slowest pace in three years. The stock fell 5.6% combined on Thursday and Friday, its worst two-day performance since July.

"Investors are assigning higher risk to companies with negative cash flow," said Brian Mulberry, chief market strategist at Zacks Investment Management. "I do think what you're seeing now is investors voting with real money to redefine what they see as 'quality.'"

In fact, the AI trade was already at a disadvantage early in the week. Meta Platforms Inc. raised its capital expenditure plan for this year when it released earnings on October 21. Since then, the stock has fallen 12% cumulatively. A measure of the company's credit risk rose to a record high. On Friday, S&P Global Ratings lowered the credit rating outlook of the Facebook parent from stable to negative, noting that it is unclear when Meta's spending will generate revenue that exceeds rising costs.

"Investors are starting to reward companies that can prove they have the ability to turn spending into revenue and actual investment returns, while punishing companies that have not yet done so, or are still increasing spending," said Chris Osmond, chief investment officer at Fifth Third Wealth Advisors.

Pessimism has grown to the point that even companies able to generate steady free cash flow have been sold off. Microsoft reported that revenue growth in its Azure cloud business was faster than expected, with free cash flow close to $19 billion. But its stock was still dragged down this week, falling 1.6% on Friday.

Concerns about AI are not limited to mega-cap companies. Software developer ServiceNow released a disappointing quarterly sales forecast, once again triggering market concerns about AI disruption, and its stock plunged a record 31% on Thursday. Meanwhile, Fortinet Inc. cut its services business sales forecast, triggering a selloff in cybersecurity stocks.

Alphabet's survival challenge

Perhaps no company better represents the contradiction between AI risks and rewards than Alphabet. Its results showed strong growth in AI search queries. But because Google earns less from this type of traffic than from traditional search, revenue from the business was disappointing. Search accounted for nearly 56% of the company's revenue last year, so once it declines, the potential impact could be extremely severe.

Alphabet had already faced concerns that its search business market share could be hit by competition from chatbots launched by companies such as OpenAI. Strong results over the past few quarters had temporarily eased those concerns, but this earnings report showed that Alphabet may be disrupting its own business with its own hands.

"Alphabet is building infrastructure, but in doing so it may be risking cannibalizing its own business," Saglimbene said. "The next phase of AI will enter a 'show me' phase. The market has very high expectations for companies building AI infrastructure, and every quarter will be like a report card, either proving those expectations are justified or making the market question them. When reality does not match the market narrative, the stock price decline can be very severe, as we have already seen."

Software stocks fall

This earnings season has once again revived market concerns about AI disrupting the software industry. Products from companies such as Anthropic and OpenAI could weaken software companies' pricing power and compress profit margins.

According to compiled data, so far this earnings season, 90% of the software companies in the S&P 500 have beaten earnings expectations, but only 70% have beaten revenue expectations. Both figures have worsened from the previous quarter, when 100% beat earnings expectations and more than 80% beat revenue expectations.

"The market is very uneasy about which software companies can survive in the AI era," said Ben Connard, chief investment officer at Carnegie Investment Counsel.

Several software stocks have been sold off this earnings season after companies reported weak results or outlooks. In addition to ServiceNow and Fortinet, communications software developer Twilio Inc. fell 18% on Friday due to disappointing guidance. Industry research called this "clearly concerning" because it "means growth will slow significantly compared with the third quarter."

Devouring cash

Massive spending on AI infrastructure continues to erode the free cash flow of mega-cap technology companies. Of the four hyperscalers, three — Amazon, Meta and Alphabet — posted negative free cash flow this quarter. Amazon's negative free cash flow was close to $35 billion, compared with free cash flow of $430 million a year earlier. Microsoft was the exception, with positive free cash flow of $18.6 billion.

"In the past, we used to look at technology companies in a particular way," said Saglimbene of Ameriprise. "They used to be asset-light companies with abundant cash flow and very reliable growth. Now they have become asset-heavy companies, their cash flow situation has changed, and in some cases the reliability of their growth has changed too. All of this means they need to be looked at in a different way. Given the scale of the money these companies are investing, you have to value them differently than in the past."

Capex challenge

Data center capital expenditure remains in full swing. Meta Platforms slightly raised its forecast for such spending this year, and its future spending commitments rose to $825 billion. Microsoft's capital expenditure in the first fiscal quarter was below expectations due to bottlenecks, but the company said spending will increase in the second half of the fiscal year ending in June next year. Meanwhile, Alphabet's future spending obligations jumped to well over $1 trillion.

"I think demand for AI tools is still astonishingly high, which means this capital expenditure is necessary," said Mulberry of Zacks Investments. "But the question now is, we have already spent $800 billion this year, how do we monetize it? And when you do monetize it, can it translate into positive cash flow — that is, can it be profitable?" news_keyword_pub,usstock,MSFT&GOOG&AMZN&.IXIC&FTNT Account opening QR code start

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