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Will Rebounding Google Ad Sales Power Alphabet's Earnings?

By Danny Vena - Oct 23, 2019 at 9:29AM

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Stronger advertising boosted the search giant last quarter. Will it continue?

Google-parent Alphabet (GOOGL -1.77%) (GOOG -1.79%) is among the plethora of technology companies that will be reporting results as earnings season kicks into high gear next week. It's scheduled to release its third-quarter financial report after the market close on Monday, Oct. 28.

A surprising jump in ad sales in Q2 gave the search provider a much-needed jump-start, sending Alphabet more than 9% higher in the wake of its earnings. But even with those gains, the stock has barely kept pace with the broader market in 2019.

Can Alphabet continue the momentum that began last quarter, or were the positive results a one-off? Let's look at a few areas that investors should watch when the company reports earnings.

Building with the Google logo at night.

Image source: Google.

Revenue growth

Alphabet's second-quarter revenue grew to nearly $39 billion, up 19% year over year. Ignoring the impact of currency exchange rates, it delivered growth of 22%. The results were substantially better than analysts' consensus estimates of $38.15 billion, and accelerated sequentially from 17% growth in the first quarter.

Wall Street is expecting more of the same. While management doesn't provide quarterly guidance, analysts' consensus estimates for the third quarter are calling for revenue of $40.33 billion, up 19% year over year -- similar to its performance last quarter -- so there is an expectation that the solid growth will continue.

Other revenue categories

While most of Alphabet's revenue is a result of Google's ad sales, there are two other categories the company hopes will eventually be able to move the needle, though they are small by comparison today.

The "other revenue" segment is home to many of these potential revenue drivers -- like cloud computing, Pixel phones, Nest cameras, Google Home, the Google Play Store, and other hardware. This segment boosted the Q2 results, as revenue of $6.18 billion grew 40% year over year, up from $4.43 billion. That accounted for 16% of Alphabet's total revenue for the quarter.

Google Cloud is the biggest contributor to "other revenue." Alphabet CEO Sundar Pichai boasted about cloud growth on the Q2 conference call, saying it had reached an annual revenue run rate of "over $8 billion, and continues to grow at a significant pace," though he declined to quantify it. The company is betting heavily on the segment, planning to triple the size of the sales force dedicated to its cloud business.

Another area of interest is "other bets," a catchall for Alphabet's high-risk, high-reward endeavors, including its self-driving car segment Waymo, Google Fiber, life-sciences division Verily, drone unit Wing, and balloon segment Loon. Currently the amount of revenue these ventures produce is negligible at $162 million, up 12% year over year. But any one of these early stage businesses could eventually be a huge profit generator, so the segment bears watching.

Traffic acquisition costs

One area that has frustrated investors in recent years is Google's traffic acquisition costs (TAC), or the amount the company pays to partners like Apple to direct users to Google's search engine. The growing trend toward mobile has caused these costs to spike, as mobile search and programmatic -- which have been the company's strongest growth areas -- generally carry higher TAC than desktop.

After several years of sizable increases, TAC as a percentage of revenue has begun to moderate, declining to 22% of Google's ad revenue in Q2, down from 23% in the prior-year quarter. Investors will be watching this metric to ensure it doesn't start to climb again.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Danny Vena owns shares of Alphabet (A shares) and Apple and has the following options: long January 2021 $190 calls on Apple and short January 2021 $195 calls on Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), and Apple. The Motley Fool has the following options: short January 2020 $155 calls on Apple and long January 2020 $150 calls on Apple and recommends the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.

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