Alphabet Inc., the parent company of Google, has demonstrated cost discipline in several areas, yet multiple factors could hinder margin expansion in the third quarter.
Despite exceeding earnings and revenue expectations on Tuesday afternoon, Alphabet’s stock declined by the end of the extended session.
Several issues in the latest figures drew scrutiny. Notably, YouTube’s revenue was lower than expected and showed a slowdown compared to the first quarter.
Management attributed this to easier comparisons in the first quarter, which faced a period of negative growth, whereas the second quarter had to contend with the beginning of increasing advertising revenue from Asian e-commerce players like Temu.
A significant concern for investors emerged during the company’s earnings call. Alphabet’s executives highlighted trends that could affect margin expansion in the third quarter. President Ruth Porat mentioned that headcount might increase as the company hires college graduates and anticipates higher “depreciation and expenses associated with higher levels of our investment in technical infrastructure.”
Wall Street analysts, such as Ben Reitzes from Melius Research, suggest that the market may be concerned about how quickly Alphabet can expand its margins in the near term.
Reitzes noted that while Alphabet’s 32.4% overall operating margin in the June quarter exceeded expectations, any comments hinting at slower margin growth attract attention given the current focus on efficiency.
The company’s significant investment in technical infrastructure, driven by its ambitious artificial intelligence goals, is a key factor influencing spending. Rivals like Meta Platforms Inc., Amazon.com Inc., and Microsoft Corp. are also making similar investments. Porat’s comments indicate that third-quarter operating margins will reflect increased depreciation and related expenses from these investments.
Reitzes highlighted the importance of watching depreciation trends on earnings per share and gross margins, especially for the 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 trend continues into Wednesday’s regular session, it would mark Alphabet’s most subdued stock-price reaction to earnings since shares declined 0.1% following the March-quarter report last year.
