Alphabet Stock Drops. Capital Spending Surprises Wall Street.

Alphabet

gave investors a happy surprise for the second quarter in a row with its profit of $1.89 a share for the three months ended June 30. That was 4 cents above the average forecast, and 30% above last year’s quarter.

Revenue also edged ahead what Wall Street had penciled in. At $84.74 billion, it exceeded the consensus number of $84.3 billion, and rose 13.6% year over year.

But capital spending for the quarter was higher than most analysts were expecting. It rose to $13.2 billion, up from $12 billion in March 2024 and less than $7 billion in June 2023. Alphabet President Ruth Porat told listeners on Tuesday’s earnings call that quarterly capital expenditures will continue at, or above, the March level of $12 billion for the rest of the year.

Even before the AI sweepstakes, Alphabet had been competing against rivals like

Microsoft

and

Amazon.com

to sell cloud computing services. Now, it’s also pouring R&D dollars into generative AI as it bids to hold off the threat the tech 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 expenses with layoffs and consolidation of some operations. That expense control was a reason for the upside surprise in March earnings. Tuesday, Porat said that head count declined from March to June, and that hiring has slowed greatly.

Mark Kelley, an analyst who covers the internet sector for

Stifel
,

said on Wednesday that it had been “a relatively straightforward quarter with few surprises” for Alphabet, but noted that capital expenditures had been “a bit higher” than Wall Street was expecting.

Google also logged continuing growth in search advertising, which brought in $48.5 billion for the quarter. “Our strong performance this quarter highlights ongoing strength in search and momentum in cloud,” said CEO Sundar Pichai, in Alphabet’s press release.

But ad sales at YouTube grew 18%, or $8.7 billion, slower than the 21% rise over the three months ended March 31. “The debate out of earnings is likely to be around YouTube given revenue growth came in below expectations,” said Ronny Josey, an analyst at Citigroup.

On the earnings call, Porat said that operating margins will rise over the next year. But she warned that September’s margin will see pressure from depreciation and spending on AI and cloud computing.

Revenue was strong everywhere the company did business. In the U.S., revenue grew 6% from March and 17% from June 2023. Year-over-year growth in Europe and Asia was better than 12%, on a constant currency basis, but the strong dollar reduced the reported growth in those regions to around 10%.

“Google is the company that is truly bringing AI to everyone,” said Pichai on the call. The company’s AI-driven search Overview now summarizes search results in many regions. Pichai said the summaries are increasing engagement among young users, and provide a new perch for advertisements, above and below.

Search now allows a user to put in images. Soon, it will accept video inputs from a phone. AI will understand the context of a person’s queries, said Pichai, so you’ll be able to ask “what did I eat at the restaurant in Paris?”

Three months ago, Alphabet showed that even a widely followed megacap firm could smash through forecasts, when it beat earnings estimates by 25%, although one major surprise of the earnings season was its capital spending. AI rivals, such as

Microsoft

and

Facebook

parent Meta Platforms, are also pouring money into the tech.

Combine that top-line tailwind with Google’s position at the forefront of generative artificial intelligence, and you get a stock that is up 30% this year—twice the rise of the

S&P 500.

Still, at Tuesday’s closing price of $181.79, Alphabet goes for 21 times the consensus forecast for 2025 earnings. Many think that isn’t too expensive for a member of the Magnificent Seven.

“We do not think softer growth at YouTube should overshadow the transformation underway within the company’s core Search business. Google is in the process of infusing generative AI overviews into Search and is seeing improving engagement metrics and higher levels of user satisfaction,” Dan Ives, an analyst at Wedbush, said in a research note.

Like three-quarters of the analysts who follow Alphabet, Ives’ colleague Scott Devitt rates the stock a Buy. There is nearly 15% upside to his $205 price target.

In June, Alphabet began paying a 20 cent quarterly dividend. It is also working its way through a $70 billion stock buyback program.

Operating expenses grew little, from March to June, but they are increasing, nevertheless. Depreciation must grow when capital spending jumps from $32 billion in the 2023 year to an expected $50 billion in 2024.

On the earnings call, no one asked Chief Executive Sundar Pichai about the company’s reported attempt to acquire cloud security vendor Wiz for $23 billion. As of Monday evening, Wiz was still intent on remaining independent. But Alphabet, and Microsoft, will continue to try to enhance the security of their computing platforms.

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

“Given the complications across the technical ecosystem and feedback across so many stakeholders, we believe that user choice is the best path there,” said Pichai.

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