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Slowing Ad Revenue Growth Whacked Alphabet’s Share Price -- and It Should Have

By Motley Fool Staff – May 3, 2019 at 12:22PM

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Sales are still rising, but the curve has investors worried.

Google parent Alphabet (GOOGL -1.82%) (GOOG -1.98%) has its fingers in a whole lot of pies, but most of its revenues still come from online ad sales, so news that on a percentage basis, ad revenue growth in the first quarter had decelerated again to around 15% got more attention from Wall Street than its otherwise solid earnings.

In this segment of the Market Foolery podcast, host Chris Hill and MFAM Funds' Bill Barker talk about why investors' response to the Q1 report was reasonable, the company's opaqueness, YouTube's monetization issues, Alphabet's outlook and investment thesis, and more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.

This video was recorded on April 30, 2019.

Chris Hill: First-quarter profits for Alphabet were great. That's not the problem. Declining ad revenue. That's the problem, because Alphabet is in the advertising business. Shares are down about 8%. When you're as big as Alphabet is, that somewhere in the neighborhood of $75 billion worth of market cap.

Bill Barker: Yeah. I would say that the earnings were good, not great. What it comes down to is how the market does and should value growth rates. You've got ad revenue growth of 15% for this quarter. That's a continued deceleration. It was about 20% in the fourth quarter, a little over 20% in the third quarter last year, 24% in the second quarter of last year, and 24% this time last year. There's a little bit of adjustment that you need to make for currency translations, but still, that's a four-in-a-row-quarter deceleration of the most important part of their business. It's still growth. That's pretty good growth. 15% year-over-year growth, given the size of this company, is not something to dismiss. But if you're into pattern recognition, it's a pattern that is slapping you in the face at the moment.

Hill: So you don't view the stock drop today as a buying opportunity for someone who's been sitting on the sidelines on Alphabet.

Barker: If they've been sitting on the sidelines, I think Alphabet's going to continue to be one of the dominant performers and growers in the market. If you've got a longer time horizon, sure. One of the issues here is that Alphabet is not very forthcoming about the details of things. I was reading a Deutsche Bank analyst report. Really, there was a little bit of hostility underneath the words here about the ways in which Alphabet is not as forthcoming as at least this analyst would like them to be with the details of why things are happening the way they are.

Hill: I didn't see that note, but I did see a report about Ruth Porat, who's the CFO at Alphabet, a tremendous hire, and Alphabet's shareholders have done very well during her time as CFO. She mentioned comments about YouTube that the company didn't really expand upon. It was basically, "Yeah, YouTube's a problem." [laughs] I'm paraphrasing. I'm doing this in a broad stroke. But yeah, that was basically what Ruth Porat said about YouTube. "Yeah, YouTube, that's also a problem." And there wasn't any color beyond that. It's amazing to think that YouTube -- as big as it is, as dominant as it is -- and you look at Ruth Porat's comments, and honestly, any comments related to YouTube coming from within the company, and one common theme that we've heard for years is, "Yeah, we haven't really optimized this yet. We haven't really turned this into the video equivalent of what Google Search is, and that's what we want to do." And it's understandable.

But in some ways, it's similar to the way you and I talk about Starbucks, and we're like, "Wow, it's amazing to think that Starbucks has gotten this far and food is, at varying points in its history, pretty good, to dismal." It's never been, "Wow, they are firing on all cylinders with food the way they are with coffee." It's the same thing with Alphabet and YouTube. It's like, yeah, YouTube is the most dominant video search engine and the second-most-dominant search engine, period, in the United States, but we still haven't worked out the bugs.

Barker: Yeah. They're not doing the job that some would like, giving granularity toward understanding the numbers. One of the comments in this Deutsche Bank, which I'm quoting, just because it jumped out at me, this is not usually how things are phrased. It says, "Site revenue growth of 90%, with Google providing its investors, its typically limited assistance understanding the weakness."

This is one individual's recounting. I'm sure Google would beg to differ. But that's part of what's out there today. If the numbers are continuing to come up with a slowing -- though still, I would say, impressive -- revenue growth, you've got the ad revenue, I think I read some data point that Google and Facebook are on track to have 40% of global ad revenue by next year, that may have been online, but that would be staggering. Do you know? It can't be all ad revenue, can it? [laughs]

Hill: I haven't seen that, but we can put someone on that, our substantial staff. Let me step back for a second, because you raise an interesting point about Alphabet and this one analyst. I'm curious, what is reasonable to expect? Put the analyst aside for a second. Just for shareholders, what is reasonable to expect out of company leadership, in terms of how much insight they're going to give us, particularly when, in the case of Alphabet, things didn't go as well as they would have liked?

Barker: What is reasonable? I think that in Google's case, they're more in the position of making the rules. They don't need anybody's help. The reasonableness is, in some sense, a function of who you need help from, in terms of gathering more money. If you're dependent on Wall Street to fund your next capital raise, whether through shares or secondary or bond offering, or just to prop up your price, because it's nice to have analysts saying nice words and recommending that your stock be bought, you have a different set of needs than Google does. Their needs are more in the world of secrecy and not really giving any information to its competitors about why they may have weakness, or why they may have accounted for something over this quarter in a way that you don't quite understand.

I think they are more OK with not everybody understanding the details of their business, particularly as they run a business which is highly dependent on continuing to addict people to the service. When you talk about the flaws in YouTube's monetization, those are not flaws in terms of getting people to be addicted to YouTube and spending more and more time on the site. That is currently a bigger chunk of the game than monetizing those hours spent on YouTube, although they're certainly cramming more and more ads on YouTube, is my experience.

Hill: Absolutely. So, reading between the lines of what you just said, it sounds like the bigger and more successful the company, the less likely they are to be helpful to analysts and shareholders understanding stumbles?

Barker: Yes, I would say. Depends on management. There are managements, individuals, who are more willing to be more forthcoming and admit mistakes and say, "This is where we are." That's a category thing. But I think it's largely true that you're not getting the same level of disclosure from the Godzillas in this market than the needy.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to its CEO, Mark Zuckerberg, is a member of The Motley Fool's board of directors. Bill Barker is an employee of Motley Fool Asset Management, a separate, sister company of The Motley Fool, LLC. The views of Bill Barker and Motley Fool Asset Management are not the views of The Motley Fool, LLC and should not be taken as such. Bill Barker owns shares of Alphabet (C shares). Chris Hill owns shares of Starbucks. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Facebook, and Starbucks. The Motley Fool has a disclosure policy.

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