Key Takeaways:
Amazon and Alphabet booked $121 billion in one-time unrealized investment gains last quarter, inflating S&P 500 earnings by roughly 15 percent.
"The gains are paper mark-ups, not cash arriving," Jonathan Weil, a finance columnist at The Wall Street Journal, said in an analysis of the earnings.
Alphabet's other income of $98 billion was 71 percent of its quarterly profits, while Amazon's $53.4 billion windfall was 66 percent. Both stem largely from stakes in AI developer Anthropic, plus SpaceX for Alphabet.
The windfalls mean the S&P 500's 31 percent trailing earnings growth overstates operating strength. Excluding Amazon and Alphabet, growth was 24 percent, and the index trades at about 27 times trailing earnings versus a 16-times historical average.
The mark-ups are part of net income under generally accepted accounting principles, but they are unrealized and inherently nonrecurring. Alphabet's portion alone represents about 10 percent of second-quarter S&P 500 earnings, and Amazon's another 5 percent, according to the Journal's analysis.
Beneath the paper gains, both companies' operating engines are strong. Amazon's operating income rose 43 percent year over year to $27.5 billion, while Amazon Web Services grew 37 percent to $42.2 billion, its fastest pace in 18 quarters. Alphabet's revenue rose 24 percent to $119.8 billion, operating income climbed 30 percent to $40.8 billion, and Google Cloud's revenue accelerated to 82 percent growth.
The forward drag comes from capital spending. Amazon lifted this year's plan to about $220 billion, citing rising memory costs. Alphabet raised its full-year plan to as much as $205 billion after capital spending doubled year over year to $44.9 billion in the quarter. Depreciation from those buildouts lands on income statements for years afterward.
Consensus estimates imply Amazon earning about $9 per share over the next year against the $12.44 it earned over the past 12 months, and Alphabet about $13 against $19.93. The gap is mostly the windfalls coming back out, not a forecast of decline. On next year's earnings, both companies cost about 27 to 30 times.
Alphabet wears the price better. It is cheaper on both bases, its operating margin expanded to 34 percent even while spending doubled, and its cloud business is accelerating. Amazon's business is running faster right now, but at about 27 times forward earnings versus about 30, Alphabet is the better value.
The distortions extend beyond the two companies. Wall Street's "Street earnings" routinely exclude recurring costs like stock-based pay — at least 65 S&P 500 companies — yet analysts waved through the investment windfalls. Nvidia last quarter reported $58.3 billion of net income and steered analysts to a lower $45.5 billion adjusted figure that excluded unrealized gains, a rare instance of conservatism.
The investment gains come as Anthropic itself prepares to go public, with an IPO that could arrive in September or early October at a valuation of $965 billion. Amazon is estimated to own a mid-to-high-teens percentage of Anthropic, while Alphabet was estimated to own 14 percent as of March.
For investors, the takeaway is that the trailing multiples making Amazon and Alphabet look cheap rest on paper gains that won't repeat. The next test is Anthropic's IPO, which will reset the value of both stakes and could swing the same income lines the other way if the startup's valuation falls.
This article is for informational purposes only and does not constitute investment advice.
