Big Tech’s AI Stakes Skew Earnings

Big Tech’s Stellar Earnings Are Skewed by Windfalls from AI Giants

Corporate profits for the technology sector are painting a rosier picture than reality, largely due to significant investment gains from stakes in burgeoning artificial intelligence companies. Giants like Microsoft, Amazon, and Alphabet have reported robust quarterly earnings, heavily bolstered by their valuations in private AI powerhouses such as Anthropic and OpenAI, and in some cases, SpaceX.

These AI startups have witnessed a dramatic surge in private market valuations, with both Anthropic and OpenAI reportedly valued at nearly $1 trillion each, fueled by the relentless AI boom. Microsoft and Amazon hold private stakes in these companies, while Google is invested in Anthropic. Consequently, these tech behemoths are compelled to recognize the appreciation of their holdings as investment gains on their quarterly income statements. However, this accounting maneuver does not reflect profits generated from core business operations like software sales or services.

According to LSEG, these paper gains from private investments have disproportionately inflated the overall earnings growth for the S&P 500 in the latest quarter. Tajinder Dhillon, LSEG’s head of earnings and equity research, noted that while headline earnings growth for the S&P 500 stood at approximately 48% year-over-year, this figure significantly moderates when excluding the investment gains from private AI companies.

Stripping out these gains from Alphabet and Amazon’s private company stakes alone would reduce the aggregate earnings growth to around 29%, Dhillon explained. This adjusted figure aligns much more closely with analysts’ initial forecasts of 24% growth for the quarter.

“The headline earnings numbers were very much inflated by equity gains in OpenAI, Anthropic, and SpaceX,” commented Gil Luria, managing director and head of technology research at D.A. Davidson. “Having said that, these types of moves tend to even out over time, which is why we typically exclude them from a non-GAAP view and from forecasts.”

While most analysts prudently exclude these one-time accounting events from their projections, their inclusion has contributed to a higher-than-average number of earnings upside surprises this quarter. LSEG data indicates that companies have reported earnings that are, on average, 7% above expectations, a notable increase from the historical average of 4.4% above consensus.

This earnings dynamic is amplified by the significant influence of mega-cap technology stocks, which already hold a substantial weighting within the broader market. The so-called “Magnificent Seven” companies accounted for approximately 35% of the S&P 500’s second-quarter revenue, according to LSEG. Over the past year, this select group of tech stocks has represented roughly one-third of the overall large-cap index.

These investment gains are typically categorized under “other income,” leading to variations in how tech companies report these figures.

Amazon, a substantial backer of OpenAI with a $50 billion commitment made in late February, and an early investor in Anthropic, reported a remarkable surge of over 240% in its earnings from a year ago. However, without these investment gains, its growth would have been closer to 17%. In the reporting quarter, Amazon recognized a $53.4 billion gain, “primarily from” its investment in Anthropic.

Alphabet experienced a similar trend, largely driven by its investment in SpaceX. The Google parent company holds an approximate 5% stake in Elon Musk’s aerospace firm. Alphabet’s reported bottom-line growth nearly tripled, reaching close to 300%. Excluding the gains from SpaceX and Anthropic, this growth would have been closer to 23%.

For Microsoft, the impact was somewhat less pronounced. Nonetheless, its earnings growth received an approximate 10-percentage-point boost from an investment gain in Anthropic, contributing to a net income gain of $3.2 billion, which the company attributed mainly to Anthropic. Microsoft also reported a $480 million gain related to its OpenAI stake.

This interplay underscores the deep entanglement of these nascent AI companies with established Big Tech players, even before their potential public market debuts. Both Anthropic and OpenAI have filed confidentially with the SEC, signaling expectations of an initial public offering within the next year.

Luria cautioned that this earnings dynamic could introduce more volatility moving forward, as it can work in both directions. SpaceX, for instance, has experienced a roughly 50% decline from its post-initial public offering peak. “Specifically, based on where SpaceX is trading now, GOOGL will likely have a big reversal in their mark-to-market when they report the September quarter,” he predicted. “A successful Anthropic IPO in September could offset that, but it is too early to tell.”

Conversely, some market participants view the underlying earnings growth as inherently healthy, even with the significant boost from Big Tech’s private investments. Jeff Kilburg, founder and CEO of KKM Financial, characterized the “enormous” profits from tech giants as mere “sprinkles” on top of an already robust earnings season. Kilburg described the surge in corporate earnings as “jaw dropping,” independent of the inclusion of private asset valuations.