Alphabet's Earnings Miss Expectations: 5 Metrics Investors Should See

Alphabet (GOOGL 1.54%) (GOOG 1.43%) reported third-quarter 2019 results after the market closed on Monday. 

Both Class A (GOOGL) and Class C (GOOG) shares of the Google parent and tech giant were down 1.9% at 10:24 a.m. EDT on Tuesday. We can attribute the market's reaction to earnings per share missing Wall Street's consensus estimate. In 2019 through Monday's regular trading session, Class A and C shares have gained 21.7% and 23%, respectively, ever so slightly trailing the S&P 500's 23.2% return.

Here's an overview of Alphabet's third quarter in five numbers.

Image source: Alphabet.

Revenue jumped 20%

Alphabet's net sales increased 20% year over year to $40.5 billion, edging by the $40.3 billion that analysts had been expecting. In constant currency, revenue increased 22%. Reported revenue growth represents a slight acceleration from last quarter's 19% year-over-year increase, while the constant currency metric was unchanged sequentially. 

Here's how the segments -- Google and other bets -- performed:

Data source: Alphabet. YOY = Year over year.

The company's revenue growth was once again driven by strength in mobile search, YouTube, and Google Cloud, CFO Ruth Porat said on the earnings call.

Ad revenue growth of 17% year over year represents a slight acceleration from the second quarter's 16%, which in turn was a slight acceleration from the first quarter's 15%. While these are small increases, this is good news, considering that this metric fell off rather sharply in the first quarter from the fourth quarter of 2018's 20% result.   

Google's "other revenue" year-over-year growth continued to be strong, down just 1% from the second quarter's 40% showing. Growth continued to be driven by Google Cloud and Google Play. 

Google incurred a $1.1 billion settlement with France

In September, Google agreed to pay a 500 million euro ($554 million) fine to settle an investigation in France over its tax practices. Moreover, the company agreed to pay 465 million euros (about $510 million) in back taxes in the country. French authorities launched the tax fraud probe in 2016.

This settlement naturally negatively affected Alphabet's bottom line. 

Operating income rose 6.2%

Operating income grew 6.2% year over year to $9.2 billion. The Google segment's operating income came in at $10.9 billion, up 14% year over year. Other bets' operating loss widened 29% to $941 million. Operating margin shrank to 23% from 26% in the year-ago quarter because costs continue to increase faster than revenue. 

Total cost of revenue, including traffic acquisition costs (TAC), increased 23% year over year. Other cost of revenue jumped 31%, primarily driven by Google-related expenses, Porat said on the earnings call. She added that "the biggest contributor, again this quarter, was costs associated with our data centers and other operations, including depreciation, followed by content acquisition costs, primarily for YouTube and mostly for our advertising-supported content, but also for our newer subscription services, YouTube Premium and YouTube TV." Operating expenses increased 27% year over year, with growth in head count -- primarily in research and development and sales and marketing -- being the largest contributor.

EPS fell 23%

Net income landed at $7.1 billion, down 23% from the third quarter of last year. That translated to earnings per share (EPS) of $10.12, also down 23%. Wall Street was looking for EPS of $12.46, so the company fell short of analysts' expectations. 

Operating cash flow was $15.5 billion 

Alphabet's operating cash flow was $15.5 billion, up from $13.2 billion in the prior year's quarter, and its free cash flow was $8.7 billion. The company ended the period with about $121 billion in cash and marketable securities on its balance sheet.

Bonus item: Waymo update

While Porat didn't provide any metrics about Waymo, I'd be remiss not to include her update about the company's self-driving vehicle subsidiary just because it doesn't fit into this article's theme. Here's what she had to say about Waymo, which is included in the other bets segment:

At Waymo, we're extending fully driverless opportunities on a small scale to participants in our early rider program in Metro Phoenix. [This service launched last December.] We're also testing long-haul truck driving on Arizona freeways. And we're continuing to test Waymo vehicles in various geographies, the newest of which is ... southern Florida. In addition, we have begun 3D mapping in Los Angeles.

3D mapping of the environments surrounding roads is a necessary step before the company can begin testing its vehicles in an area. So this move implies that Waymo has its sights set on launching in LA. 

Playing the long game

In short, Alphabet continues to invest heavily to fuel long-term growth, which means that it's sacrificing some current profits. This isn't a bad trade-off for long-term investors who believe in the company's ability to continue to grow nicely.