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Stock Buybacks vs. AI Capex: What’s the Real Difference?
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When a company buys back its stock, it reduces the number of shares outstanding. That means its profits are divided across fewer shares.
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Consider a company that generates $10 billion in earnings with one billion shares outstanding. That equates to an EPS of $10 ($10 billion divided by 1 billion). Now imagine that it buys back 10% of its shares.
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If the company still makes the same $10 billion profit, those earnings are now divided across just 900 million shares. That increases EPS to $11.11. EPS has increased by roughly 11% without the underlying business making one additional dollar in profit.
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You can see why buybacks are such a popular management strategy.
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But capex is a very different thing. Capex – short for capital expenditures – is money companies spend on physical assets like data centers and equipment.
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Imagine the company spends its money building out AI infrastructure. Its share count doesn’t change, and there’s no immediate increase in earnings.
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The company is spending billions today because management believes those investments will generate substantially greater profits tomorrow. But there are no guarantees. That’s what makes the sheer scale of Big Tech’s capex so daunting.
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If AI delivers the kind of gains those companies expect, their enormous investments could prove incredibly valuable. But there’s a risk.
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What happens if tech companies build too much capacity and margins fall? Or what if technological advances render all that expensive AI infrastructure obsolete faster than expected?
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What if the profits don’t justify the billions of dollars spent?
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Unlike buying back stock, increased capex doesn’t automatically improve EPS. All that investment has to actually pay off.
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And that’s why I’m watching this earnings season closely…
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Why This Earnings Season Is a Turning Point for AI Stocks
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This earnings season could be an important turning point for the AI theme.
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For the past few years, investors have generally rewarded companies for investing aggressively in AI. The assumption is that spending big will deliver outsized profits over time. But investors are increasingly demanding proof.
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We saw that with Alphabet. It reported record quarterly revenue and massive growth in its cloud business. But the stock was hammered due to its rapidly growing capex and its first-ever quarter of negative free cash flow.
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By comparison, Microsoft surged more than 15% after reporting strong cloud growth and better-than-expected results. Crucially, it also indicated that upcoming capex would be lower than anticipated. The company would also continue to generate plenty of cash.
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And then there was Amazon. Its shares surged after reporting its strongest cloud growth in four-and-a-half years. That provided evidence that its huge investment is matching strong customer demand. In short, it’s not blindly building capacity in the hope of attracting new customers.
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That’s why this earnings season could mark an important change. Wall Street isn’t necessarily turning against AI spending. But investors are becoming much more selective about which companies they’re prepared to reward.
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That’s where things get really interesting for us as traders…
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The more a company invests, the greater the expectations become. And when those expectations aren’t met, the reaction can be brutal.
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With hundreds of billions on the line this year alone – and even more to follow – we’re bound to see plenty more trading opportunities.
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Happy Trading,
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Larry Benedict
Editor, Trading With Larry Benedict
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