Alphabet (GOOG +1.44%)(GOOGL +1.71%) released fourth-quarter 2018 results on Monday after the market closed, easily exceeding expectations yet again. But similar to last quarter's impressive performance, Alphabet's latest beat was amplified by one-time items related to the activities of its various investment arms. Some on Wall Street also balked at the report, as spending at Alphabet's core Google segment soared.
With shares down around 2% early Tuesday as of this writing -- albeit after a roughly equivalent rise in Monday's trading ahead of the news -- let's take a closer look at how Alphabet ended the year.
Image source: Alphabet/Google.
Alphabet's headline numbers
Quarterly revenue climbed 21.5% year over year (23% at constant currency) to $39.28 billion. That translated to earnings of $8.948 billion, or $12.77 per share, up 31.6% from adjusted net income of $9.70 per share in last year's fourth quarter.
As I noted in my earnings preview last week, Alphabet does not provide specific quarterly guidance on sales or earnings. So for perspective, most analysts watching the stock were modeling lower earnings of $10.86 per share on a more modest 20.5% increase in revenue, to $38.94 billion.
That said, Alphabet's earnings were bolstered in the fourth quarter by a $1.3 billion unrealized gain recognized under its other income and expenses (OI&E) line "related to a non-marketable debt security investment." But even excluding that item, its bottom line would have arrived slightly above expectations at $10.91 per share.
CFO Ruth Porat praised the "strong" 23% revenue growth for the full-year 2018, adding, "With great opportunities ahead, we continue to make focused investments in the talent and infrastructure needed to bring exceptional products and experiences to our users, advertisers, and partners around the globe."
Check out the latest Alphabet earnings call transcript.
Digging deeper
Alphabet divides its business into two primary segments: Google and Other Bets. Here's how they fared in the fourth quarter on a year-over-year basis:
| Metric | 3 Months Ended Dec. 31, 2017 | 3 Months Ended Dec. 31, 2018 | Growth (YOY) |
|---|---|---|---|
| Google revenue | $32.192 billion | $39.122 billion | 21.5% |
| Google operating income | $8.595 billion | $9.7 billion | 12.9% |
| Other Bets revenue | $131 million | $154 million | 17.8% |
| Other Bets operating income (loss) | ($748 million) | ($1.328 billion) | N/A |
Data source: Alphabet quarterly filing. YOY = year over year.
To be clear, management warned three months ago that cost of sales would climb at the end of the year, driven largely by a combination of higher sales and marketing expenses during the holidays and planned content acquisition costs at YouTube. Indeed, total cost of revenue jumped 26%, to $17.9 billion, and operating expenses rose 27% to $13.2 billion.
On Google
Advertising continued to represent the bulk of Google segment revenue, climbing 19.9% year over year to $32.6 billion. Within that, ad revenue from Google's own properties rose 21.5% to just over $27 billion, and revenue from network members' sites grew 12.5% to $5.6 billion. Paid clicks on Google properties soared 66%, while cost-per-click (a metric that helps measure how much Google makes per ad) fell 29% -- an expected consequence of outsized growth from YouTube, where ads tend to reach users earlier in the purchase funnel so they monetize at lower rates. Traffic acquisition costs (TAC) climbed a healthy 15% year over year, to $7.4 billion, an encouraging trend with the pace of TAC's increase once again trailing growth in total ad sales.
And of course, we can't forget Google's other (nonadvertising) revenue, which soared 31% year over year during the holiday period to $6.5 billion, thanks to growth from Cloud, hardware, and the Google Play store.
On Other Bets
Meanwhile, Alphabet's Other Bets segment remained spectacularly unprofitable, as expected, incurring an operating loss of over $1.3 billion as modest sales from the group of early stage, high-potential businesses continued to come primarily from Fiber high-speed internet and Verily life sciences products.
During the subsequent conference call, management lauded progress from Other Bets' Waymo self-driving vehicle business, which launched its Waymo One app in December enabling program participants to hail and pay for rides. Just over a month ago, Verily also announced a $1 billion investment from private equity firm Silver Lake, proceeds from which Porat says will help the company move forward with "plans that are complementary and additive to its current life sciences portfolio."
Looking forward
"Within [operating expenses], we remain focused on prioritization in order to optimize resources for longer-term growth in sizable markets," Porat said during the call. "You'll see us continue to support our priority areas with increased head count, which will remain concentrated in [research and development]."
But Porat added that Alphabet expects its growth in operating expenses to "moderate quite significantly" in 2019.
At the same time, CEO Sundar Pichai stated Alphabet will continue making "substantial investments" in new and expanded office space -- including $1 billion in capital improvements for a new campus in New York City in 2020 -- as well as data center construction and expansion going forward.
On the latter, Pichai said: "This is an important long-term investment that lays the groundwork for our future computing needs, primarily to accelerate machine-learning across our business but also to support the opportunities we see in Cloud, Search, Ads, and YouTube. More than 20 years on, there is still tremendous opportunity for Google to help people save time, learn new things, grow their businesses, and build stronger communities."
In the end, this was as solid a report as any Alphabet investor could have hoped for. The company delivered strong top- and bottom-line growth in spite of -- or, perhaps more likely, aided by -- its fast-rising expenses and investments to foster growth. And it's clear that Alphabet is intent on extending its industry leadership through those investments.
