Please ensure Javascript is enabled for purposes of website accessibility

Alphabet Is Taking a Page From the Amazon Playbook

By Adam Levy – Updated Apr 26, 2018 at 9:23AM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Spend now; profit later.

Investors got a big shock when Alphabet (GOOG -0.36%) (GOOGL -0.58%) reported its first-quarter earnings. The Google parent company is spending a lot more than expected.

Capital expenditures totaled $7.3 billion last quarter, up from $2.5 billion in the first quarter last year. ($2.4 billion of that went toward acquiring the building that houses some of its New York offices.) Total costs and expenses on its income statement climbed 33% year over year, outpacing revenue growth of 26%.

But that revenue growth was the best number Alphabet has seen in four years.

The message to investors was very clear, and CFO Ruth Porat made it crystal-clear during the earnings conference call (emphasis added):

The opportunity set ahead of us is quite extraordinary and we remain focused on investment to support long-term revenue and profit growth. We have both the business confidence to invest appropriately in the next phase of innovation, as well as clarity about some very compelling opportunities that in our judgment will enable us to create shareholder value.

Spending more now to take advantage of a long-term revenue opportunity sounds a lot like another company you might've heard of -- Amazon (AMZN 1.20%).

Google employees wearing colored shirts standing in the shape of the Google G.

Image source: Google.

Extraordinary upside

During the earnings call, Porat called out two markets with "extraordinary upside": cloud and hardware.

Google has seen rapid growth from its cloud-computing division, which requires a lot of capital to keep growing and expand. Google Cloud surpassed $1 billion in the fourth quarter, and management says it continues to see momentum this year.

Google Cloud is still well short of Amazon's Amazon Web Services division, which generated $5.1 billion in net revenue during the fourth quarter and $17.5 billion for the full year last year. But Google says it's the fastest-growing public cloud company, and the rapid growth of even its largest competitors bodes well for the opportunity.

Hardware is another capital-intensive industry. The company acquired the smartphone division of HTC last quarter, bringing on 2,000 new hardware engineers. Those engineers will support the Pixel line of smartphones, the Google Home smart speaker, Nest thermostats, and other hardware products coming down the pipeline. Google CEO Sundar Pichai says the company is still two or three years away from reaching the scale it wants to see, so it's going to keep investing.

Amazon's hardware business has been a major success with its e-readers, tablets, streaming media devices, and smart speakers. Each of those products fosters a deeper relationship with Amazon while providing valuable data for the company to continue improving its core marketplace and services. Google is looking for similar success with its hardware products.

Both cloud computing and hardware fall under Google "other revenues" when Alphabet reports its earnings results. As the company continues to invest more and more into these areas, Google may face pressure to break out its results for those segments individually, just as Amazon was pressured into breaking out AWS results.

It's worth noting that Alphabet has dozens of other areas of investment as well, including YouTube, Waymo, Verily, and others.

Haven't I heard this before?

Alphabet had previously ramped up spending to capitalize on long-term opportunities about five years ago. That spending eventually prompted it to hire Porat as CFO and break out its other bets financials to show investors the financial results of its moonshots. Porat had successfully reined in spending until last quarter.

But unlike last time, Alphabet is already showing that its spending can pay off in revenue growth. As mentioned, its first-quarter revenue growth was its highest year-over-year rate since 2014.

That should give investors confidence that Alphabet will see significant revenue growth as a result of its investments over the next few years. While it might put pressure on its profit margin in the near term, investors should have confidence that the long-term opportunity will be worth it.

Amazon CEO Jeff Bezos famously said, "Your margin is my opportunity." Alphabet finds itself in a similar position as Amazon today, and it should follow the lead of the wealthiest man ever. He might be onto something.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Adam Levy owns shares of Alphabet (C shares) and Amazon. The Motley Fool owns shares of and recommends Alphabet (A and C shares) and Amazon. The Motley Fool has a disclosure policy.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Alphabet Inc. Stock Quote
Alphabet Inc.
GOOG
$98.81 (-0.36%) $0.36
Alphabet Inc. Stock Quote
Alphabet Inc.
GOOGL
$98.17 (-0.58%) $0.57
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$115.15 (1.20%) $1.37

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
329%
 
S&P 500 Returns
106%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 09/27/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.