Alphabet, Google’s parent company, brought back an old crowdpleaser for its quarterly earnings results on Tuesday—it grew revenue faster than spending for the first time since 2021.
But while the financial feat was music to the ears of investors and sent Alphabet shares up as much as 7%, it remains to be seen whether it’s a performance the company can repeat in the quarters ahead. With the tech industry locked in an expensive A.I. arms race and the economy still uncertain, keeping a lid on costs while expanding revenue will put Alphabet's leadership team to the test.
“I've got a lot more confidence that we'll see revenue growth maintain momentum. I think on the cost side it's going to be a little bit tougher,” Bernstein analyst Mark Shmulik told Fortune on Wednesday.
Alphabet’s revenue increased 7% year-over-year to $74.6 billion in the second quarter, as strong results in search advertising and YouTube pushed the company’s topline above Wall Street expectations. Meanwhile, Alphabet’s total spending—which includes both cost of sales as well as operating expenses—increased by only 5% year-over-year, to $53.4 billion.
While the balance between sales and spending is key to running a viable business, Alphabet has struggled to achieve the right ratio in recent quarters. At one point last year, Alphabet’s spending was growing at three times the clip that revenue was growing. The last time Alphabet’s revenue growth was ahead of spending was the final quarter of 2021.
After a period of tightening ad budgets, marketers appear to be opening their wallets to reach Google users again. Digital advertising's recovery is shining through this quarter, said Gerrit Smit, a manager at the Stonehage Fleming Global Best Ideas Equity Fund.
Alphabet’s boost in revenue in Q2 came from an acceleration in Google Search revenue growth and “ongoing signs of stabilization and advertiser spending on YouTube” as well as strong subscriptions to YouTube and revenue from hardware, Bank of America analyst Justin Post said in a Wednesday report.
While total revenue growth of 7% is lackluster compared to the double-digit growth rates that Alphabet has previously delivered, it was enough to top analyst expectations and outpace the company’s spending.
Where is Alphabet's penny pinching paying off?
Alphabet’s sales and marketing expenses in Q2 increased by a scant 2.3%—a significant change from this time last year, when sales and marketing spending was up 26%. And Alphabet’s general and administrative costs actually decreased by $176 million from the prior year in Q2. (which is interesting, given all the billable hours the company must be paying lawyers for its numerous regulatory challenges). The company had little to say about these cost controls in its 10-Q report, citing a “combination of factors, none of which were individually significant.”
Company executives were a bit more helpful during Alphabet’s earnings call, pointing to recent efforts aimed at increasing efficiency within the organization, such as merging certain teams and re-assigning employees to priority areas with the best potential payoffs. Google began the year by announcing plans to cut 12,000 employees and it has slashed perks.
“We do remain very focused on durably re-engineering our cost base,” Ruth Porat, Alphabet’s longtime CFO who was appointed the newly created position of president and chief investment officer.
Sticking to that plan will be difficult amid fierce competition from Microsoft and other companies building an arsenal of A.I. tools that threaten the Google business model. Alphabet CEO Sundar Pichai stressed that the company would be as disciplined in its spending on A.I. projects as it is on anything else.
“All the work we are doing on efficiency and optimization applies on the A.I. side as well,” Pichai said.
Even so, the company noted that capital expenditures were set to rise. While capex was lower than expected in Q2, it will increase in the months ahead, largely due to the need to upgrade company data centers for A.I.
“With this result, it’s obviously becoming even clearer that Google is definitely not to be underestimated with artificial intelligence,” Stonehage Fleming’s Smit said.
But, he noted, “in terms of artificial intelligence, it is going to take material investment."
