Alphabet shares fall as capital spending surprises investors.

Alphabet surprised investors for the second straight quarter, reporting earnings of $1.89 per share for the three months ended June 30. That was 4 cents above the average forecast and 30% higher than the year-ago quarter.

Revenue also beat Wall Street forecasts. At $84.74 billion, it beat the consensus figure of $84.3 billion and rose 13.6% year over year.

But capital spending in the quarter was higher than most analysts expected, coming in at $13.2 billion, compared with $12 billion in March 2024 and less than $7 billion in June 2023. Alphabet CEO Ruth Porat told listeners on Tuesday’s earnings call that quarterly capital spending would remain at or above the March level of $12 billion for the rest of the year.

Even before it entered the AI ​​contest, Alphabet was competing with rivals like Microsoft and Amazon to sell cloud computing services. Now, the company is also pouring research and development money into generative AI to try to contain the threat the technology could pose to its core business, Google’s search engine.

To free up cash for those AI and cloud investments, Google has tried to control spending by laying off employees and consolidating some operations. That spending control is one reason for the positive surprise in March’s results. On Tuesday, Porat said headcount declined from March to June, and hiring slowed significantly.

Mark Kelley, an analyst covering the Internet sector for Stifel
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said Wednesday that it had been “a relatively straightforward quarter with few surprises” for Alphabet, but noted that capital spending had been “a bit higher” than Wall Street expected.

Google also saw continued growth in search advertising, which generated $48.5 billion for the quarter. “Our strong results this quarter highlight the continued strength in search and momentum in the cloud,” CEO Sundar Pichai said in Alphabet’s press release.

But YouTube’s ad sales rose 18%, to $8.7 billion, slower than the 21% increase in the three months ended March 31. “The earnings debate is likely to revolve around YouTube, given that revenue growth has been below expectations,” said Ronny Josey, an analyst at Citigroup.

On the earnings call, Porat said operating margins would expand over the next year. However, she cautioned that the September margin would be pressured by depreciation and amortization and spending on artificial intelligence and cloud computing.

Revenue was strong everywhere the company operated. In the U.S., revenue increased 6% from March and 17% from June 2023. Year-over-year growth in Europe and Asia was above 12%, at constant exchange rates, but the strong dollar reduced reported growth in those regions to around 10%.

“Google is the company that’s truly bringing AI to everyone,” Pichai said on the call. The company’s AI-driven search preview now summarizes search results in many regions. Pichai said the summaries increase engagement with younger users and provide a new perch for ads, both above and below.

Search now lets users insert images. Soon, it will accept video input from a phone. AI will understand the context of a person’s queries, Pichai said, so you can ask, “What did I eat at a restaurant in Paris?”

Three months ago, Alphabet showed that even a widely followed, mega-cap company can beat forecasts by beating earnings estimates by 25%, though one of the biggest surprises of the earnings season has been its capital spending. AI rivals like Microsoft and Facebook parent Meta Platforms are also pouring money into the technology.

Combine that leading tailwind with Google’s position at the forefront of generative artificial intelligence, and you get a stock that’s up 30% this year, twice the previous year’s gain.

S&P 500.

Still, at Tuesday’s closing price of $181.79, Alphabet is worth 21 times consensus 2025 earnings estimates. Many think that’s not too much for a member of the Magnificent Seven.

“We don’t think YouTube’s slower growth should overshadow the transformation underway in the company’s core search business. Google is integrating generative AI insights into search and is seeing improvement in engagement metrics and user satisfaction levels,” Wedbush analyst Dan Ives said in a research note.

Like three-quarters of the analysts who follow Alphabet, Ives’ colleague Scott Devitt rates the stock as a buy. His $205 price target offers room for upside of nearly 15%.

Alphabet began paying a quarterly dividend of 20 cents in June. The company also launched a $70 billion share buyback program.

Operating expenses increased slightly from March to June, but they are still rising. Depreciation and amortization are expected to increase as capital spending increases from $32 billion in 2023 to a projected $50 billion in 2024.

On the earnings call, no one asked CEO Sundar Pichai to explain the company’s attempt to acquire cloud security vendor Wiz for $23 billion. As of Monday night, Wiz still intended to remain independent. But Alphabet and Microsoft will continue to try to improve the security of their computing platforms.

Pichai was asked about Google’s decision Monday to abandon a plan that would have eliminated third-party software “cookies” from its Chrome browser. Privacy advocates condemn software trackers, but that’s how most advertisers track consumers online.

“Given the complications within the technical ecosystem and the feedback from so many stakeholders, we believe user choice is the best path forward,” Pichai said.

Write to Bill Alpert at william.alpert@barrons.com