Alphabet Inc. exceeded both earnings and revenue expectations in its latest quarterly report, but its stock experienced a decline by the end of the extended trading session on Tuesday. This downturn in stock price can be attributed to several factors that have raised concerns among investors.
One notable issue was the performance of YouTube, Alphabet’s popular video-sharing platform. While YouTube remains a significant revenue driver for the company, its revenue for the quarter came in lighter than expected and showed a deceleration compared to the first quarter. Alphabet’s management explained that YouTube faced easier comparisons in the first quarter, where growth was measured against a period of negative performance. In contrast, the second quarter’s results were compared to a period of ramping advertising revenue from Asia-based e-commerce players like Temu. This tougher comparison base contributed to the deceleration in YouTube’s revenue growth.
However, the more significant concern for investors emerged during the company’s earnings call. Alphabet executives highlighted several trends that could impact the company’s margin expansion in the third quarter. One of these trends is the planned increase in headcount as the company hires college graduates. Additionally, Alphabet anticipates higher depreciation and expenses associated with its substantial investment in technical infrastructure. Ruth Porat, Alphabet’s President, noted during the earnings call that these factors would affect operating margins in the upcoming quarter.
Wall Street may be cautious about Alphabet’s ability to expand its margins in the near term. Ben Reitzes, an analyst at Melius Research, pointed out that while Alphabet reported a robust 32.4% overall operating margin for the June quarter, any comments hinting at a slower pace of margin expansion tend to attract attention. This is particularly true given the current emphasis on efficiency among internet companies. Alphabet and its peers, including Meta Platforms Inc., Amazon.com Inc., and Microsoft Corp., have been striving to be more cost-conscious in response to past investor criticism over rampant hiring and lavish employee benefits.
A key factor driving Alphabet’s increased spending is the hardware needed to support its ambitious artificial intelligence (AI) projects. This is not unique to Alphabet; other tech giants like Meta, Amazon, and Microsoft are also heavily investing in AI infrastructure. Porat’s comments about increased depreciation and expenses reflect the significant capital expenditures these companies are making to maintain their competitive edge in AI. Reitzes emphasized the importance of monitoring these expenditures for their potential impact on earnings per share (EPS) and gross margins. He noted that given the recent surges in capital expenditure at Alphabet and other leading cloud providers, the commentary on depreciation is particularly relevant for investors tracking the financial performance of the so-called “Magnificent 7” tech companies, which include Microsoft, Amazon, and Meta.
Alphabet’s shares fell by 2% in Tuesday’s extended session, reversing earlier gains. This decline occurred after an initial positive reaction to the earnings report. If this trend continues into Wednesday’s regular trading session, it will mark Alphabet’s most muted stock-price reaction to earnings since shares ticked 0.1% lower following the March-quarter report last year. This muted response indicates that while Alphabet’s financial performance exceeded expectations, investor concerns about future margin expansion and increased spending on AI infrastructure have tempered enthusiasm for the stock.