What to Watch When Alphabet, Inc. Reports Q2 Earnings

Image source: Alphabet Inc.

Alphabet Inc. (GOOG -2.17%) (GOOGL -2.08%) is set to release second-quarter 2016 results Thursday, July 28, 2016 after the market close, This will mark the Google parent's third time breaking out its performance on a segment basis, so now is great opportunity for investors to review what to expect from the internet juggernaut.

For perspective, last quarter didn't sit particularly well with the market; Alphabet shares plunged around 5% the day after its Q1 report when it technically fell short of Wall Street's fickle near-term expectations, despite Alphabet CFO Ruth Porat calling it a "tremendous start to the year."

"We're thoughtfully pursuing big bets and building exciting new technologies, in Google and our Other Bets, that position us well for long-term growth," added Porat.

To that end, keep in mind Alphabet doesn't typically offer specific quarterly financial guidance. But as a point of reference, analysts' consensus estimates this time call for second-quarter revenue to increase roughly 17.1% year over year, to $20.76 billion, and result in a 14.9% increase in earnings per share, to $8.03.

As Porat alluded in her comments, we can also expect Alphabet to break down revenue and operating income for its business from two primary categories: Google and Other Bets.

Big G

Google is Alphabet's core business, and contains results from Search, Android, Maps, Chrome, YouTube, Google Play, Gmail, and Apps, Commerce, Cloud, and hardware products. But with the exceptions of Apps, Commerce, Cloud, and hardware, these sub-segments of Google -- and really Alphabet as a whole -- primarily generate revenue from advertising. Last quarter, for example, ad revenue climbed 16.2% year over year, to $18.02 billion, representing over 88.9% of Alphabet's total sales. 

Within that, we'll also receive updates on the sources of ad revenue. In Q1, ad revenue from Google's own sites increased 20.1%, to $14.33 billion, while revenue from Network Members' sites grew 3.2%, to $3.69 billion. Assuming this growth continued at a similar clip in Q2, expect strength in mobile search -- which Google began to enjoy given efforts to improve mobile ad formats last year -- to continue representing a primary driving factor.

Google's results will also include revised stats on aggregate paid clicks (up 29% year over year last quarter), as well as aggregate cost-per-click (down 9% year over year last quarter), the latter of which helps measure how much Google makes per ad. But don't be surprised if aggregate cost-per-click continues to fall; outsized growth in YouTube viewership has meant greater contributions from the video platform's TrueView ads, which tend to monetize at lower rates as they reach consumers earlier in the purchase funnel. 

Last but not least within Google is revenue from its "Other" -- or non-advertising -- sources, not to be confused with Other Bets. Three months ago, Google's Other revenue increased 24% year over year, to $2.1 billion, driven by a combination of growth at Play, Cloud, Apps, and solid contributions from hardware products like Chromecast and Nexus.

Everything else

Meanwhile, Other Bets consists primarily of early stage businesses aimed at solving big problems with a long-term mindset. These include Google Fiber (high-speed Internet), Verily (focused on longevity), Calico (life sciences), Nest (connected home products), self-driving cars, and Alphabet's X moonshot initiatives.

But as Porat explained earlier this year, "The majority of efforts within Other Bets are pre-revenue." More specifically, most Other Bets revenue to date has come from Fiber, Nest, and Verily. And as a group, they'll almost certainly remain unprofitable in Q2. Last quarter, for example, Other Bets saw revenue more than double, to $166 million, but simultaneously generated an operating loss of $802 million. 

Of course, these operating losses are more than offset by the massively profitable Google machine, which generated operating income of nearly $6.3 billion last quarter alone. But each Other Bet holds promise to become a significant financial contributor to Alphabet's consolidated results down the road. And the added transparency for investors is exactly why Alphabet restructured to begin breaking out segment-based results in the first place. 

In the end, whether those consolidated results live up to expectations this week remains to be seen. But regardless, and given its stubborn long-term focus, I suspect Alphabet won't go out of its way to appease the market's short-term demands. As long as Alphabet's core Google business continues to thrive, enabling it to continue advancing its early stage ambitions in Other Bets, investors should remain pleased with where Alphabet stands.