Alphabet’s 35% Gain in Cloud Revenue Might Be Only the Start of Something Bigger

• Alphabet stock jumped about 6% on blowout Q3 earnings.
• The tech giant saw a 35% increase in cloud revenue.
• The CEO said investments in AI are starting to pay off.

Alphabet had a strong third quarter, as its investments in AI are starting to pay off.

Big tech week is upon us, and it got off to a pretty good start with Alphabet (NASDAQ:), which posted blowout third-quarter earnings, led by a 35% surge in cloud revenue.

Alphabet, the parent company of Google (NASDAQ:), saw revenue rise 15% year-over-year to $88.3 billion, which topped estimates of $86.3 billion.

Net income climbed 33% to $26.3 billion, or $2.12 per share, which blew away estimates of $1.85 per share.

The share price jumped about 6% Wednesday in early trading.

AI investments are “paying off”

Alphabet had strong earnings across the board, and they were largely fueled by its investments in AI.

“The momentum across the company is extraordinary,” Sundar Pichai, CEO, said. “Our commitment to innovation, as well as our long-term focus and investment in AI, are paying off with consumers and partners benefiting from our AI tools.”

Alphabet’s cash cow, Google Search advertising, saw revenue climb 12% to $49.4 billion. Search revenue was buoyed by new AI features that expand users search capabilities.

Overall Google Services revenue, including Google Search and YouTube ads and subscription, jumped 12.5% to $76.5 billion. Operating income within Google Services rose 29% to $30.9 billion.

“AI is expanding our ability to understand intent and connect it to our advertisers,” Google Chief Business Officer Philipp Schindler said on the Q3 earnings call. “This allows us to connect highly relevant users with the most helpful ad and deliver business impact to our customers.”

Cloud revenue jumps 35%

Alphabet’s fastest grower in Q3 was Google Cloud, where revenue surged about 35% to $11.4 billion. The street had predicted $10.9 billion in cloud revenue. Operating income climbed from $266 million to $1.9 billion in cloud.

“In Cloud, our AI solutions are helping drive deeper product adoption with existing customers, attract new customers and win larger deals,” Pichai said.

Google is a distant in cloud computing with about 11% market share, behind Amazon (NASDAQ:) (32%) and Microsoft (NASDAQ:) (23%), but it will be interesting to see if the Q3 gains close the gap a bit. Microsoft and Amazon also report earnings this week.

Use AI to streamline costs

Meanwhile, expenses were kept in check as traffic acquisition costs (TAC) only grew 8% to $13.7 billion, while costs and expenses increased 7% to $59.7 billion. The number of employees dropped about 1% to 181,269.

Pichai said the company’s ongoing efforts to improve efficiency helped deliver an operating margin of 32%, up from 28% a year ago.

On the earnings call, Chief Financial Officer Anat Ashkenazi said the company will continue to focus on expense reduction efforts in the year ahead and beyond.

“Sundar, Ruth [Porat, Alphabet president], and her leadership team started important work to reengineer our cost structure including efforts such as optimizing our head count growth, our physical footprint, improving the efficiencies of our technical infrastructure, and streamlining operations across the company through the use of AI,” Ashkenazi said on the call. “I plan to build on these efforts, but also evaluate where we might be able to accelerate work and where we might need to pivot to free up capital for more attractive opportunities.”

Vigorously defend antitrust ruling

Alphabet has the Justice Department’s antitrust case against Google search looming over it, but that is likely to take years to resolve. But the question did come up on the earnings call.

“It’s not appropriate for me to speculate given it’s in the middle of ongoing litigation,” Pichai said. “But what I would say is, stepping back, look, we’ve always — and even as the court acknowledged, clearly, we’ve reached a position of success because we have deeply innovated, and we are continuing to do so. People have chosen us because they viewed us the best product, be it consumers or partners.”

He added that the company plans to “vigorously defend these cases” calling some of the “early proposals from the DOJ, et cetera, have been far reaching.” Earlier this month, the DOJ filed a document in the case suggesting remedies, and one alluded to structural remedies, which typically refer to breaking up a company.

For now, Alphabet stock is rare among tech giants in that it is still relatively affordable, with a forward P/E of 19. It also got a slew of price target raises from analysts after Q3 earnings. Alphabet stock still looks like a solid buy given its valuation and momentum.

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