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Alphabet Crushes Expectations on Mobile, YouTube Strength

By Steve Symington - Updated Oct 30, 2017 at 9:14AM

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The internet search giant posted stellar third-quarter results. Here's what investors need to know.

Alphabet Inc. (GOOGL -1.34%) (GOOG -1.29%) released third-quarter 2017 results on Thursday after the market closed, demolishing investors' expectations with strong top- and bottom-line results. Shares of the internet-search juggernaut jumped nearly 5% on Friday in response, easily eclipsing the $1,000-per-share mark for the first time.

Let's look at the underlying drivers for Google's parent company as it started the second half of the year and at what investors should anticipate in the months ahead.

Desk at Google with book open to various Google doodles

IMAGE SOURCE: ALPHABET, INC.

Alphabet's results: The raw numbers

Let's start with the headline numbers: Third-quarter revenue grew 23.7% year over year to $27.772 billion, net income increased 33% to $6.732 billion, and earnings per diluted share rose 32% to $9.57.

Alphabet doesn't provide specific quarterly guidance. So for perspective -- though we usually take Wall Street's demands with a grain of salt -- consensus estimates were less optimistic, calling for earnings of $8.33 per share on revenue of $27.2 billion.

Digging deeper into those results, Alphabet separates its business into two segments: Google and "Other Bets." Here's how they fared in terms of revenue and profitability:

Metric 3 Months Ended Sept. 30, 2016 3 Months Ended Sept. 30, 2017 Year-Over-Year Growth
Google revenues $16.089 billion $19.723 billion 22.6%
Google adjusted operating income* $6.774 billion $8.744 billion 29.1%
Other Bets revenues $197 million $302 million 53.3%
Other Bets operating income (loss) ($861 million) ($812 million) N/A

* Excluding the European Commission fine. Data source: Alphabet Inc. Q3 earnings release.

On "Other Bets"

"Other Bets" is comprised of early-stage, high-potential businesses, most of which have yet to generate consistent revenue, let alone profits. But given its relative cash cow in Google (more on that below), Alphabet is more than happy to foster these "bets" on the chance they could eventually generate meaningful incremental sales and earnings.

Some are already well on their way to that end. As Other Bets' operating losses narrowed, segment revenue climbed more than 50% to $302 million, primarily generated by Nest connected home products, Fiber high-speed internet, and Verily Life Sciences products.

Alphabet CFO Ruth Porat offered several updates during the subsequent conference call. Nest, for example, launched a number of notable updates including its new, more affordable Nest Thermostat E, as well as a home-security solution including the Nest Secure alarm system, Hello video doorbell, and Cam IQ outdoor security camera.

Other Bets also includes Waymo, Alphabet's self-driving car business, which announced yesterday it will commence winter-season testing in Michigan to tackle key challenges for driving in snow, sleet, and ice.

On Google

As expected, Google generated the vast majority of Alphabet's overall revenue and all of its operating income, helped by an incredible portfolio of products including Search, Chrome, Gmail, YouTube, Maps, Play, Cloud and Android.

Most importantly, Google's advertising business continues to thrive; advertising revenue climbed 21.4% year over year to $24.065 billion. That included 22.6% growth from Google properties ad sales, to $19.723 billion, led by strength in mobile search, YouTube, and desktop search. Ad revenue from network members' sites also grew 16.3% to $4.342 billion.

Next, aggregated paid clicks rose 47% year over year -- up from 52% last quarter and 44% in Q1 -- including 55% growth from Google properties, and a 10% increase from network members' properties. Aggregate cost per click (a metric that measures how much Google makes from each ad) declined 18% -- a deceleration from last quarter's 23% fall -- including a 21% drop from Google properties and a 5% decline from network members' sites. As a reminder, this drop is owed to the relative outperformance of YouTube, where the video platform's TrueView ad format tends to reach users earlier in the purchase funnel, so monetizes at lower rates.

Meanwhile, Google's non-ad products sustained their hearty growth, with revenue climbing 40% year over year to $3.405 billion, thanks to broad strength in Cloud, Play, and hardware sales.

Finally -- though I had hoped for an update on Google's handling of its enormous $2.7 billion European Commission antitrust fine, management didn't offer any new color on its reported appeal, or on efforts to appease regulators to avoid future fines. Remember, that fine was absorbed in its entirety as a separate operating-expense line in last quarter's results.

Looking forward

Again, Alphabet doesn't provide investors with specific quarterly financial guidance. But Porat did insist that the company is "committed to sales and marketing investments in Q4 for the important holiday season" -- not only related to the company's core search and YouTube platforms, but also to its hardware product lines. These hardware lines were recently expanded to include new Nest products, Pixel 2 smartphones, new Google Home smart speakers, new Chromebooks, VR headsets, and earbuds.

Investors couldn't ask for much more. Porat summed up the company's performance well by stating: "We had a terrific quarter. ... Our momentum is a result of investments over many years in fantastic people, products, and partnerships."

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