Investors punish Microsoft, Alphabet as AI returns fall short of lofty expectations

Tech giants on Tuesday talked up how customers are lapping up their generative AI-powered products, but mounting costs of developing the cutting-edge features irked investors hoping for a big boost to sales from the new technology.

Shares of Alphabet closed 7.5 percent lower, while those of Microsoft fell 2.7 percent, bringing down heavyweight tech stocks including Apple , Meta and Amazon .

Both Microsoft and Alphabet reported generous increases to their cloud revenue in the December quarter, beating Wall Street estimates, as customers lined up to test new AI features and build their own AI services.

But costs surged as well, highlighting the heavy investments these companies are making in servers, data centers and research as they compete fiercely for new customer dollars.

This hurt investor expectations that were fueled by the promise of AI, which powered a stock rally to record highs in recent months.

"A lofty valuation means even the slightest hint of disappointment will be seized on by investors, and Microsoft's guidance for revenue growth in its cloud division to slacken a little in the current quarter was enough to see the shares dip modestly," said Russ Mould, investment director at AJ Bell.

Gene Munster, a managing partner at Deepwater Asset Management, said he is looking for more from his firm's stakes in Alphabet and Microsoft.

"Investors want to see more contribution from AI," he said about Alphabet. "Microsoft is still nascent, but showing some AI uptick."

Alphabet's shares, which rose 58 percent in 2023, were trading at 22.26 times expected earnings, compared with a forward PE of 33.09 for Microsoft, 22.46 for Meta, 42.60 for Amazon and 27.73 for Apple.

Microsoft, Alphabet outperform S&P 500 Index in the past year Microsoft, Alphabet outperform S&P 500 Index in the past year

"The only problem here is that Google reported earnings the same night as Microsoft ... (it is) hard to get that AI multiple pixie dust if larger cloud players are growing faster off of larger revenues," Bernstein analysts wrote in a note.

Google and Microsoft's stock drop wiped off about $140 billion and $80 billion in their market value, respectively.

Shares of chipmaker AMD , which boosted its 2024 forecast for AI processors to $3.5 billion on Tuesday, fell 2.5 percent. Analysts had previously expected AMD to sell $4 billion to $8 billion worth of AI chips, said Summit Insights analyst Kinngai Chan, adding the stock's valuation is also pegged to those figures.

Alphabet's capital expenditure in the reported quarter shot up 45 percent to $11 billion. Meanwhile, Chief Financial Officer Ruth Porat said spending would be notably larger this year than 2023.

Microsoft also reported a 69 percent jump in capital expenditure to $11.5 billion and said it expects the metric to "increase materially" on a sequential basis.

"By providing a positive outlook ... (Microsoft) gave investors just enough to justify the current share price, but will need to continue to deliver on its growth trajectory in order to justify an even higher share price," said Gil Luria, analyst at D.A. Davidson.

Luria expects Microsoft to still be able to increase margins based on keeping its overall headcount relatively flat, and investments to come back down next year once Microsoft has enough data center capacity to meet demand.