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Alphabet Caps a Fantastic Year

By Steve Symington - Updated Feb 2, 2018 at 2:49PM

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The market isn't happy with the search giant's results. But investors should be.

Alphabet Inc. (GOOGL 5.11%) (GOOG 5.20%) released fourth-quarter 2017 results on Thursday after the market closed, detailing exception growth and profitability from its core business, as well as an enormous -- and delightfully nerdy -- incremental stock repurchase authorization.

Let's refine our search, to get a better look at what the parent company of Google accomplished over the past few months, as well as what investors can expect as it kicks off the new year.

Google headquarters office with logo on side of the building, colorful bike rack out front

Image source: Alphabet, Inc.

Alphabet's results: The raw numbers

Alphabet's consolidated quarterly revenue climbed 24% year over year to $32.32 billion and -- based on generally accepted accounting principles (GAAP) -- translated to a net loss of $3.02 billion, or $4.35 per share. But that bottom line includes a nearly $9.9 billion tax provision related to the December enactment of the U.S. Tax Cuts and Jobs Act of 2017. Adjusted for that non-cash item, Google delivered net income of $6.837 billion, or $9.70 per diluted share.

As I pointed out in my earnings preview a few days ago, Alphabet doesn't provide quarterly financial guidance. But these results were technically mixed relative to expectations for higher adjusted earnings of $9.98 per share on lower revenue of $31.84 billion.

Alphabet separates its business into two distinct segments: Google and "Other Bets." Here's how they fared in the fourth quarter:

Metric 3 Months Ended Dec. 31, 2016 3 Months Ended Dec. 31, 2017 Year-Over-Year Growth
Google revenue $25.802 billion $31.914 billion 23.7%
Google operating income $7.883 billion $8.763 billion 11.2%
Other Bets revenue $262 million $409 million 56.1%
Other Bets operating income (loss) ($1.088 billion) ($916 million) N/A

Data source: Alphabet Inc. Q4 earnings release.

Google is going strong

Right away we can see that Google's revenue growth outpaced that of its operating income. During the subsequent conference call, management noted that total cost of revenue (including traffic acquisition costs) climbed 34% year over year. These cost increases were driven primarily by Google-related expenses such as data center investments, depreciation, the fast-growing "Made by Google" family of hardware products, and content acquisition costs at YouTube.

That said, Google's core advertising business remains strong, with consolidated ad revenue growing 21.6% to $27.2 billion. Within that, ad sales from Google's network members' sites increased 12.6% to just under $5 billion, driven by programmatic strength. And ad sales from Google's own sites increased 23.8% to $22.2 billion, driven by mobile search, desktop search, and YouTube.

Aggregate paid clicks grew 43% year over year, including 48% growth from Google's sites and an increase of 13% on network members' properties. Aggregate cost per click -- a measure for how much Google makes per ad -- fell 14%, including a 16% drop from Google properties and a 4% decline from those of network members. Investors shouldn't be overly concerned with the trend of falling aggregate cost per click, however, as it's primarily a function of the outsized growth of YouTube, where Google's TrueView ads tend to reach consumers earlier in the purchase funnel and monetize at lower rates.

Next, Google's non-advertising revenue grew 37.7% year over year to $4.687 billion, driven again by growth in hardware, Google Play, and Google Cloud products. CFO Ruth Porat noted during the call that Cloud, in particular, "has reached meaningful scale," reaching $1 billion in quarterly sales and standing tall as the fastest-growing major public cloud provider in the world.

"Other Bets" is growing fast, (still) unprofitable

Alphabet's Other Bets revenue climbed more than 56% to $409 million this quarter, narrowing the segment's operating losses by around 16% year over year to $916 million. As per usual, sales were primarily generated by Nest connected home, Fiber high-speed internet, and Verily life sciences products. But this also includes businesses like Waymo self-driving vehicles, which passed 4 million miles of real-world driving last quarter, and other moonshot initiatives housed under Alphabet's X division.

For the full year, Other Bets revenue grew 49% to $1.2 billion, incurring an operating loss of $3.4 billion, narrowed from a loss of $3.6 billion in 2016.

Looking forward

Alphabet again declined to provide specific forward financial guidance. But Porat did offer some color on the company's longer-term goals. While traffic acquisition costs (TAC) are expected to climb as a percentage of total Sites revenue, for example, Google expects its rate of TAC growth will begin to slow after the first quarter of 2018.

Alphabet will also maintain its capital-allocation framework, using cash to drive organic growth in big bets like Cloud, Hardware, and YouTube, as well as the underlying machine-learning initiatives that Porat reminds investors "are powering innovation across our business." 

Second, Alphabet will opportunistically consider the promise of potential mergers and acquisitions. And third, Google will look to put its cash to use in complimentary capital returns initiatives.

To that end, Alphabet's board approved an incremental repurchase of up to $8,589,869,056 of Class C stock. The odd figure is an intentional joke, representing what mathematicians describe as a "perfect number" -- a rare number that is the sum of all its proper divisors. Leave it to Google to make light of putting nearly $8.6 billion to work in such a shareholder-friendly way.

In the end, its slight bottom-line shortfall (relative to Wall Street's expectations) notwithstanding, there was little not to like about Alphabet's latest performance. And with shares still up more than 40% over the past year as of this writing, I think investors should be more than happy as Alphabet continues to reinforce its dominance from a position of strength.

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