Amazon and Alphabet: High Multiples Mask Base Earnings Reality

Two of the world's largest companies, Amazon and Alphabet, are trading at high multiples due to expected earnings for next year. On the surface, it appears that profits are expected to fall, but a closer look reveals that the market is actually adjusting for windfalls that won't repeat.

Amazon earned $62.6 billion in the second quarter, which includes a non-operating pre-tax other income of $53.4 billion primarily from its investments in Anthropic. If this windfall is removed, Amazon's stock price would be significantly lower than it appears.

The operating business at both companies is impressive, with operating income rising 43% year over year to $27.5 billion for Amazon and 30% to $40.8 billion for Alphabet. However, the forward story is driven by capital spending, which has doubled for Alphabet and increased significantly for Amazon.

The depreciation from this spending will reach income statements on multi-year schedules, contributing to next year's expected earnings being lower than last year's. This means that the market multiples are actually reasonable when considering the base earnings without the paper gains.