Key insights
- The author argues that AI investments by tech giants like Microsoft, Amazon, and Google will ultimately boost net income. Increased revenue from AI services and potential price hikes will likely outpace depreciation costs associated with AI hardware. This suggests a bullish outlook for these companies' earnings and valuations.
We constantly hear about the massive capital expenditures that companies like Google, Amazon and Microsoft incur for AI data centers. But what does that actually mean for the balance sheet? First, one of the most important financial metrics for a company is net income. Roughly speaking, it’s the amount a company has left after deducting all costs. Other key metrics, such as earnings per share (EPS), are derived from this figure. For many investors, net income is the most important figure because, ultimately, what matters is how much money a company can generate. In other words, an increase in net income is almost always viewed positively.
When Microsoft spends money on hardware, it is depreciated over a certain period (currently 6 years). This depreciation is reflected as "cost of revenue" on the balance sheet and therefore reduces net income. In other words: The more hardware, the higher the depreciation, the lower the net income, right?
Correct, but we mustn’t forget the other side of the coin: more revenue because people are paying for AI services. Companies that invest in AI ultimately unlock a new revenue stream. For net income to increase, AI companies just need to ensure they generate more revenue through AI than the depreciation on hardware amounts to, and net income will rise! Yes, personnel costs to run those models need to be includes as well but for cloud companies this is not much different than hosting one of their hundreds of other services as well.
When I look at how many companies are currently rolling out GitHub Copilot Agent or are willing to pay for Claude Opus, I have zero doubts that we’ll see a massive increase in revenue of these companies. And it’s probably only a matter of time before companies raise their prices as well. On the other hand, depreciation costs for hardware remain relatively stable, meaning an expected increase of the net income.