Big Tech profits get $160bn boost from gains on stakes in other AI companies

Big tech giants booked a more than $160bn windfall last quarter from investments in other AI companies, flattering their earnings and raising concerns that paper gains are overstating the strength of the AI boom.

Alphabet, Amazon, Nvidia and Microsoft all reported substantial boosts to their pre-tax profits in their most recent results from the ‘other income’ line in their accounts, which largely comes from valuation gains on equity stakes in other leading AI companies.

These one-off valuation boosts, derived in large part from enthusiasm around AI, risk distorting the financial picture at a time when investors are closely scrutinising tech earnings to gauge the health of the AI ecosystem.

“A couple of years ago investors started to ask about the circularity of [Big Tech] revenues,” said Ben Snider, chief US equities strategist at Goldman Sachs.

The profit boost from AI investments now “raises the question of whether the growth these companies are reporting is based on underlying demand or if it is misleading in some way,” he added.

Big Tech groups’ investments in OpenAI and Anthropic have increasingly shown up in their financial reporting in recent quarters, as accounting rules dictate that changes in the value of equity investments at the end of each quarter appear as part of the company’s profit or loss.

But their equity gains have been turbocharged this year by the public float of SpaceX, in which Google-parent Alphabet and Nvidia both own stakes. The rocket company absorbed Elon Musk’s xAI before going public, making the promise of AI data centres in orbit a key part of its pitch. The listing delivered a huge uplift for existing investors.

The ‘other income’ contribution to profits last quarter was more than double the roughly $69bn boost in the previous three-month period. The expected public offerings of Anthropic and OpenAI would see the phenomenon continue in the coming year.

In the most recent round of earnings reports, pre-tax profits reached a record at several of the Big Tech “hyperscalers”. But the main source of these increases at Alphabet and Amazon was ‘other income’ from gains on SpaceX and Anthropic, rather than new business lines or fresh cash generation.

‘Other income’ more than doubled to $97.9bn at Google parent Alphabet, and more than tripled to $53.4bn at Amazon for the three months to June 30, compared with the previous three months.

Nvidia, which has a large portfolio of equity holdings, disclosed ownership of nearly 123mn shares in SpaceX at the end of June. In the three months to the end of July, it reported $7.7bn in ‘other income’. This was less than the previous quarter, when it booked big gains on its shares in Intel.

Analysts note that the underlying earnings from the US tech sector, which plays a pivotal role in overall stock market performance, are still strong. But the lumpy appearance of AI investment gains makes it harder to get a clear picture.

These gains raised “earnings quality questions”, said Manish Kabra, head of US equity strategy at Société Générale, which had contributed to the market trimming the companies’ price-to-earnings multiples from around 25 times to 20 times.

Kasper Elmgreen, fixed income and equities chief investment officer at Nordea Asset Management, said first-half earnings “materially overstated repeatable earnings power” and that the circularity of these AI gains was “a point of attention”.

The companies only revalue their holdings in private companies following a fresh funding round, while publicly traded holdings are adjusted each quarter.

This can create a distorted impression of earnings growth for investors and analysts looking at high-level financial metrics that do not adjust for these factors company by company.

“For top-down investors, yes there’s a concern on the investments that have gone on within the tech space,” Kabra said.

Louise Dudley, a global equities portfolio manager at Federated Hermes, said that the “size of the adjustments” was “difficult to ignore” and made analysis more complex and would “undoubtedly introduce additional risk”.

But she added that the companies “deserve some credit for investing in and partnering with highly successful businesses”.

The large one-off equity revisions so far this year had the potential to create nasty downward surprises for future earning periods. “The earnings contribution you get from this sets up for potential negative earnings growth next year,” said Scott Chronert, US equity strategist at Citi.