Since their last earnings reports, Microsoft (MSFT.US) and Alphabet (GOOGL.US) have seen their share prices diverge, as Wall Street grows increasingly concerned about the drag of massive AI spending on corporate profitability.
Both tech giants are set to report results after the U.S. market close on Wednesday, and recent market trading shows investors favoring Microsoft: since its July 29 earnings report showed cloud growth at the fastest pace in four years and triggered its best single-day performance since 2008, Microsoft's stock has surged 36%. Meanwhile, Alphabet's shares have fallen 6.3% since its July 22 earnings report, when a sharp rise in AI capital expenditures pushed free cash flow into negative territory.
The market expects the Google parent's free cash flow to be negative in 2026 and 2027, while Microsoft's free cash flow is expected to decline in the current fiscal year (ending in June) before recovering in the foreseeable future.
"Companies that can prove they are generating cash for shareholders have an advantage in this market over those that cannot," said Luke O'Neill, portfolio manager at Catalyst Dynamic Alpha Fund. "That's why Microsoft has outperformed other hyperscalers over the past few months. It has demonstrated a better ability to navigate this spending-and-returns environment."
Traders are seeking hedging protection in case the massive AI spending fails to deliver returns. The price of Alphabet's five-year credit default swaps (CDS) hit a record, rising 16% this month. Microsoft's five-year CDS also hit a record, climbing nearly 9% in October and on track for a fifth straight monthly increase, the longest streak on record.
Both stocks have underperformed the broader market this year: Microsoft is up 9.9% and Alphabet is up 2.4%, while the S&P 500 has gained 13% and the tech-heavy Nasdaq 100 has risen 17%.
In assessing the two companies' spending, investors will focus on their cloud computing growth, which is generally seen as a proxy for AI-related demand. "Seeing cloud growth accelerate further would be very reassuring, because it would strengthen investors' confidence in their AI investments," said Ted Parrish, chief investment officer at Parrish Capital. He holds Microsoft shares and is considering adding to his position.
Earlier this week, Anthropic PBC's IPO filing highlighted the AI giant's deepening reliance on cloud giants. Anthropic has committed to spending at least $114 billion with Google and about $45 billion with Microsoft over the coming years, regardless of whether it uses their computing capacity. It has also committed to spending $110 billion with Amazon by 2036; Amazon will report earnings on Thursday.
Market consensus estimates show Microsoft's Azure cloud business is expected to grow 45% on a constant-currency basis. TD Cowen analyst Derrick Wood wrote in an October 14 report that Azure has the potential this quarter for an "above-normal beat," because third-party data produced "the strongest screening results in history" for it.
On Alphabet's side, Google Cloud third-quarter revenue is expected to be about $29 billion, up 91% from about $15 billion a year earlier, accelerating from 81% growth in the second quarter. "Monetization on this front is becoming clearer," said Dan Sheehan, director of portfolio management at Telos Wealth Advisors. "We are starting to see incremental returns, although that does not ease the pressure on its balance sheet."
If the two companies disappoint on cloud growth or fail to prove that spending is generating returns, their share prices could suffer the way Meta Platforms did after last week's earnings report. Although Meta showed several encouraging trends, its plan to raise future spending commitments by $125 billion to $825 billion overshadowed those highlights, sending the stock down 7% the next day.
"Right now, the fear gauge is clearly highly alert to all these spending and ROI questions," said O'Neill of Catalyst. Microsoft "is benefiting from its focus on that discipline."
Analysts expect Microsoft's capital expenditures to exceed $190 billion in fiscal 2027, up 65% from about $116 billion last year. Its free cash flow in fiscal 2027 is expected to be less than $32 billion, down from $67 billion last year, before rising to $47 billion in fiscal 2028 and $87 billion in fiscal 2029.
Consensus estimates show Alphabet's capital expenditures in 2026 are expected to more than double from $91 billion last year to $202 billion. As a result, the company is expected to generate negative free cash flow of $3.6 billion this year and negative $30 billion in 2027, before turning positive in 2028. In 2025, its free cash flow was positive at $73 billion.
"I'm not worried about Alphabet having negative free cash flow," Sheehan said. Given the durable growth of these mega-cap tech companies, he views them as a safe haven in the market. "If it wanted to, it could stop spending somewhere, and the cash flow would suddenly come back."
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