The circle of AI profit: Big Tech earns from its own hype

Big Tech's profit figures look impressive. But according to the Financial Times, there is an important nuance behind this. Alphabet, Amazon, Nvidia, and Microsoft combined for more than $160 billion in additional earnings from interests in other AI companies last quarter.

It is not about ordinary sales from the cloud, advertisements, chips or software. A large part of this profit comes from increases in the value of equity interests in companies such as OpenAI, Anthropic and SpaceX. Those are paper profits, not recurring cash flows.

Under the item "other income", large tech companies record changes in the value of their investments. Due to the huge valuations in AI, those items have increased explosively this year. As a result, the profits of some hyperscalers appear stronger than they are on an operational basis.

At Alphabet, “other income” rose to 97.9 billion dollars last quarter. Amazon accounted for $53.4 billion. Nvidia added $7.7 billion. This makes it harder for investors to determine how healthy the real AI cycle is.

Because if profit growth is mainly due to increases in the value of interests in other AI companies, then that says less about the underlying demand for chips, cloud capacity or software.

The IPO of SpaceX made this effect even bigger. Alphabet and Nvidia already had interests in Elon Musk's space company. Due to the stock exchange listing, and the acquisition of xAI by SpaceX prior to that listing, the value of those interests rose sharply.

SpaceX is increasingly presenting itself as part of the AI infrastructure, with plans for data centers in orbit. This makes the company attractive to investors who want to participate in the next phase of the AI hype.

But it also ensures circularity. Big Tech invests in AI companies, which rise in valuations due to enthusiasm about AI, and those increases in value are then reflected in Big Tech's profit figures.

Analysts call this a question of earnings quality. Big Tech's operational performance remains strong, but one-off AI gains cloud the picture. If you only look at the total profit growth, you can overestimate the repeatable profit power.

That also explains why valuations came under pressure. According to Société Générale, concerns about the quality of profits contributed to the fact that multiples of some large tech companies fell from about 25 to 20 times the profits.

In addition, there is a risk for next year. If these paper profits do not return, the reported earnings growth may suddenly turn into headwinds.