We’re approaching the end of another US earnings season, and aside from NVIDIA, who reports later in August, all the ‘Magnificent 7’ have released their quarterly results.
On the face of it, results were pretty good. But mixed valuations, soft results in places, and AI losing interest for some investors, meant markets reacted poorly overall.
We’ve also seen a reset of risk appetite across major markets, although not directly related to results from the ‘Magnificent 7’. We think the rebasing of expectations could be a good catalyst for the coming quarters.
Here are our key takeaways.
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Cloud growth accelerated, with soft spots
The big cloud players (Alphabet, Microsoft, Amazon) had a point to prove. Markets were hoping the reacceleration of growth earlier in the year was here to stay, but there was some nervousness in the air going into earnings season.
The good news is, cloud growth was strong across the three key players.
Last year’s disappointing growth looks like it’s behind us. There were a few spots of weakness where growth wasn’t quite at the levels markets were looking for. Although in the case of Microsoft, we’re talking the difference between 30% and 31%.
The benefits of artificial intelligence (AI) are starting to feed into results. But outside AI, growth is a little sluggish.
Estimates for next quarter suggests little to no acceleration in cloud growth. We think that’s underestimating some of the tailwinds. For example, Microsoft’s still struggling to service all the demand its seeing, and as it brings new capacity online it should pave the way for more revenue.
Where is the revenue from AI?
This has long been the key question mark around the AI revolution.
How long until companies can build AI products and services delivering real revenue streams. We think the process has started but are still cautious on how quickly.
The big cloud providers are already seeing an AI spending boost. But for this to be long term and sustainable, there needs to be revenue streams down the line too.
There was some good news on this front, mainly from Meta and Alphabet.
AI has been integrated directly into Google Search in some regions and data suggests increased usage as a result. Advertisers are also seeing benefits from using Alphabet's suite of AI tools that help boost the quality of ad targeting.
Meta called out similar trends, and the data on ad-revenue growth offered proof. Ad-revenue can be split into two buckets – price and volume. You can raise volume with more ad slots or eyeballs but getting advertisers to pay more for each slot (price) is a different challenge. What we saw over the quarter is that price is now a major part of ad revenue growth, as Meta’s AI ad-optimisation tools gave advertisers real world benefits.
AI investment still going strong
Leaders like Musk, Nadella, and Zuckerberg think further ahead than just the next quarter or two. And all the major players are still investing more and more into the AI transition.
The size of investment is a sign of confidence that returns will come but it’s also a source of nervousness for investors. Companies can capitalise the investment costs, so it doesn’t immediately hit the income statement. But over time those costs come through, and margins are starting to feel the squeeze.
Cash isn’t really an issue. Most of the Magnificent 7 generate a lot and there are huge hoards sitting on their balance sheets. The scale of the investment is mammoth though. The Magnificent 7 stocks that have reported so far have spent $128bn on capital expenditure over the quarter, up from $71bn the quarter before.
They aren’t stopping there either. Meta was very clear that it's spending whatever it takes to keep a leadership position in the AI world. We heard similar things from Microsoft, with plans to spend even more over the coming quarters.
One positive for NVIDIA is that a good chunk of this infrastructure spending will likely be on its chips. Expectations are lofty, but we expect to see a strong revenue performance from results later this month. Of course, there are no guarantees.
Key takeaways for investors
Is the AI trade over? Not in our view.
Valuations became uncertain, which called for perfect results and that wasn’t what we saw. But there were plenty of positive take aways, and valuations are more attractive now than before the results.
The key risk we see over the coming quarters is a slowdown from the US consumer. Recent economic data has been soft, and while a recession isn’t predicted, odds have been rising.
Now could be a good time to make sure you’re well diversified.
This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Investments rise and fall in value so investors could make a loss.
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