Alphabet Q1 earnings disprove AI cannibalization of search
Alphabet's first-quarter results showed that AI is expanding search queries and ad yields, but surging capital expenditures are pressuring free cash flow.
Alphabet posted first-quarter results that decisively ended a two-year Wall Street narrative predicting conversational AI would cannibalize its core search business. Total revenue rose 19% year over year, while earnings per share hit $5.11. This demolished the consensus estimate of $2.6327, marking a 94.1% beat and the company's fourth consecutive quarterly surprise.
Alphabet's Search & Other segment generated $60.40 billion in revenue, with Chief Executive Sundar Pichai confirming that "AI continues to drive search usage and queries are at an all-time high." Rather than replacing traditional queries, Gemini-powered AI Overviews are expanding commercial ad inventory at higher yields. Advertiser Hilton EMEA captured one-third more clicks for one-fifth of its previous spend.
Search is no longer functioning as the sole mega-cap growth engine for the company. Google Cloud revenue surged 63% to $20.03 billion, demonstrating accelerating enterprise adoption of AI infrastructure. Profitability in the cloud division improved drastically, with operating margins expanding to 32.9% from 17.8%. The unit's backlog nearly doubled compared to the previous quarter, exceeding $460 billion.
The stock market's immediate reaction suggests hesitation despite these metrics. Although Alphabet has rallied 90.75% over the past year, the stock has lagged the S&P 500 since the earnings release. At $351.99, the shares trade at a forward price-to-earnings ratio of just 25, leaving room for appreciation. A consensus of 57 analysts maintain a buy rating with a $434 target, implying 23% upside.
The primary risk for investors remains the sheer scale of required capital expenditure. First-quarter capex more than doubled to $35.67 billion, directly causing free cash flow to collapse by 46.63%. Management has signaled that this spending is not a temporary spike, raising full-year 2026 capex guidance to between $180 billion and $190 billion. Spending in 2027 is expected to climb even higher, leaving the return on this massive infrastructure buildout unproven on a quarterly basis.
