High Wire Act

You storm into Lamplighter HQ, intent on meeting. Now. The door barely slows you down. Some printed pages flash from your hand to my desk. They're ones I wrote.

You start: "this," eyes narrowing, "tells me allllllll about ‘the big idea’ — companies moving “investing” from their balance sheet to investing through their P&L and how that’s a crucial thing for investors to understand right now."

"That's right," I blink, struggling to join the conversation.

"So does this," more Lamplighter print appears.

"Companies investing through their P&L has been a big source of confusion in the marketplace for a while. It’s been a part of some successful investments for us." I manage, concern creeping in.

"Then why are you telling me about Google. It writes code. Shouldn't it be investing through its P&L — investing in people — like everyone else? Isn't that the best way for it to make money? Why is it blowing out its spending on chips and wires and racks to $85 billion this year?"

Staff versus stuff

All of that is true. Google writes code. Its business revolves around clever people doing cool stuff with computers. This is exactly the sort of thing that favors expensive software engineers and not quite so much machines and buildings. For years Google's investment in real-world things — fixed capital — ran about 10% of its revenue. It built data centers and designed chips to support its code writing adventures, but the balance of its spending went to people — software engineers — through salary and stock, not to stuff and things.

It’s Google's job, as a company, to put money to work where ever it'll earn the most return. It spent so much of its resources on coders because that’s where the returns were. It could replicate their product — code — infinite times at no additional cost. Investing 10% of its revenue into stuff was just enough to make this happen.

Generative AI is tilting that balance. Don't pity the poor software engineers. They're not missing out. AI is enabling more productivity. So far its meant more demand for Google's services. It also needs more machines to make it work.

In July, Google announced that it would spend $85 billion on fixed investments this year. That's 22% of its expected revenue — twice the portion it's spent on that kind of thing in the past. It's gone back to investing the old-fashioned way — the way accountants picture a company investing — adding stuff to its balance sheet.

Is this good for the business?

Return to office

If I came to you and said "I can do a 30% annual return. Minimum. Invest with me. Probably, I can get over 50%." That would seem like a pretty tasty promise. It might even seem suspicious. You might report me to my regulator for misleading advertising.

I would never promise that. Markets sometimes serve those kinds of chances, but not always and its never a promise.

Google has a different set of opportunities than I do, though. And it did say that. OK, it didn't "say" that, but if you read the subtext in their results, that's what they say.

In the 12 months leading up to June 2024, Google spent $11 billion more on fixed investments than you'd expect based on the 10% it used to spend. Income from "Cloud" — where that additional spending is going — increased $6 billion in the next 12 months. If we say it takes about a year for those investment dollars to show returns, that's $6 billion of additional income on $11 billion of additional spending, a 55% return in that first year. There are other things going on under the hood, but that's the rough math.

And that return has been increasing. Cloud kept 48 cents of every additional dollar of revenue from Q1 to Q2. From Q4 to Q1, that share was 28%. This is a feature of "fixed" investments. They don't increase directly with the volume of business. It also supports Google casting its spending as a race to catch clamoring customers rather than an unhinged spending bender.

Is this good for investors?

Balances and Checks

If it can get a return in the teens, it should spend that money. That's what investors expect. That's all its share price needs to work. It's results point to a much higher return on that spending right now. So, hell yeah, it should be spending investors’ money on that.

Google's gone back to spending on stuff versus staff. The math favors this. AI’s tipped that balance. That’s where the checks are going and that spending is doing great work for the business. Google’s share price makes the effort an attractive one for investors.

Disclaimer: None of this is investment advice. It's meant to illustrate ways LCM thinks about investing. Things that LCM decides are good investments for LCM and its clients are based on many criteria, not all of which are covered here. Some or all of LCM's ideas may not be suitable for other investors. LCM does not recommend investing either long or short any position mentioned. LCM may own positions in some of the companies mentioned. Some of its ideas will lose money — investing entails risk. See full disclaimer here.