Alphabet’s Earnings Beat: What’s Holding Back the Stock?

Alphabet Inc., the parent company of Google, has shown cost discipline in various areas, yet several factors could impede margin expansion in the third quarter.

Despite surpassing earnings and revenue expectations on Tuesday afternoon, Alphabet’s stock still declined by the end of the extended session.

Several points in the latest figures drew investor scrutiny. For instance, YouTube’s revenue was lower than expected and decelerated compared to the first quarter. Management explained that YouTube faced easier comparisons in the first quarter, which was up against a period of negative growth, while the second-quarter results were compared to the beginning of ramping advertising revenue from Asian e-commerce players like Temu.

A more significant issue for investors was highlighted during the company’s earnings call. Alphabet’s executives pointed out trends that could impact margin expansion in the third quarter. President Ruth Porat mentioned that headcount could rise as the company hires college graduates and that Alphabet faces higher “depreciation and expenses associated with higher levels of our investment in technical infrastructure.”

Wall Street analysts, such as Ben Reitzes from Melius Research, indicate that the market might be concerned about the pace at which Alphabet can widen its margins in the near future. Reitzes noted that while Alphabet’s 32.4% overall operating margin in the June quarter exceeded expectations, any comments suggesting a slower pace of margin expansion attract attention given the current emphasis on efficiency.

Significant investments in technical infrastructure, driven by Alphabet’s ambitious artificial intelligence goals, are key factors influencing spending. Rivals like Meta Platforms Inc., Amazon.com Inc., and Microsoft Corp. are making similar investments. Porat’s comments indicate that third-quarter operating margins will reflect increased depreciation and expenses from these investments.

Reitzes emphasized the importance of monitoring depreciation trends on earnings per share and gross margins, especially for leading tech firms known as the Magnificent 7, which include Microsoft, Amazon, and Meta.

Alphabet’s shares fell 2% in Tuesday’s extended session, reversing an earlier upward trend. If this movement continues into Wednesday’s regular session, it would mark Alphabet’s most subdued stock-price reaction to earnings since shares fell 0.1% following the March-quarter report last year.