Alphabet (GOOG/GOOGL) moved down ~1.5% in pre-market trade after
the company reported disappointing earnings and margins yesterday afternoon.
Fourth quarter revenue growth remained steady, rising 21.5% year/year, a rate that has been sustainable in recent years. Google's core advertising business continues to perform well, which comes as no surprise given that the platform is essentially the backbone of the internet.
Another positive development was that traffic acquisition costs (TAC) grew 15%, down from 20% growth in the third quarter. The TAC mix fell to 23% of advertising revenue from 24% in the fourth quarter last year. The TAC headwind remains but is moderating.
However, operating profit grew just 7% to $8.2 bln, which missed estimates by almost 5%. Operating margins fell to 21% from 24%. Alphabet beat EPS on a GAAP basis, but excluding a $1.3 bln unrealized gain from non-marketable debt and other one-time items, EPS came in at ~$10.95, roughly in-line with estimates.
Google continues to invest in its cloud computing business, which is a distant third to Amazon Web Services (AMZN) and Microsoft's Azure (MSFT).
The great success of YouTube is also weighing on profitably. YouTube is a prime beneficiary of the secular shift in media consumption. However, YouTube is a massive business that comes with higher content costs relative to the core advertising business. Therefore, a higher mix of YouTube revenue weighs on margins.
Research & Development costs grew 40% to $6 bln, and Sales & Marketing expense grew 18% to $5.1 bln, leading to a 26% increase in total expense.
On the call, CFO Ruth Porat said that the 64% growth in capital expenditures achieved in the fourth quarter would slow in 2019.
Some investors are understandably frustrated by the opacity of Alphabet's financials. The parent company does not break out revenue for YouTube; Android, the dominant mobile operating system worldwide; or the Google Cloud Platform. There is no doubt that YouTube is a massive and profitable business, but without clarity on the top-line, investors are left to complain about margin contraction.
The company still has Waymo in its back pocket, which seems to have the lead in autonomous driving technology and represents huge potential going forward. Opacity is causing concern over costs for now. Perhaps investors should be happy that Google continues to strive for innovation and to invest in growth for future returns.
The company also announced a $12.5 bln share buyback program.
The stock sits today at a level roughly unchanged from that of this time last year; investments in growth continue to constrain the bottom line. Patient investors may be rewarded eventually.
Despite consistent healthy growth, Google has become more like a value stock. With a ~$780 bln market value, Alphabet trades at ~24x EPS estimates and just over 11x EV/EBITDA, which is roughly comparable to Facebook (FB).
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