Alphabet Stock Pops Despite Earnings Miss

Alphabet (GOOGL -1.97%) (GOOG -1.96%) reported first-quarter 2020 results after the market closed on Tuesday. 

Class A (GOOGL) and Class C (GOOG) shares of the Google parent and tech giant jumped 7.9% and 7.7%, respectively, in after-hours trading on Tuesday. This fact would usually bode well for the stocks' performances on Wednesday, but this is not a typical market. Coronavirus-related news is largely in the driver's seat. 

We can attribute the market's initial reaction to revenue beating Wall Street's consensus estimate. The market was relieved that the company's ad revenue didn't take an even bigger hit in March, when many companies halted or lowered their ad spending due to the COVID-19 pandemic.

In 2020 through Tuesday's regular trading session, Class A and C shares are down 8% and 7.7%, respectively, slightly beating the S&P 500's negative 10.8% return.

Here's an overview of Alphabet's first quarter in four numbers.

Image source: Alphabet.

Revenue rose 13%

Alphabet's net sales increased 13% year over year to $41.2 billion, exceeding the $40.3 billion that analysts had been expecting. In constant currency, revenue increased 15%.

For context, in the third and fourth quarters of 2019, reported revenue rose 20% and 17%, respectively, year over year.

Here's how the revenue broke out:

Data source: Alphabet. YOY = Year over year.

Within Google properties, Search and other revenue grew 8.7% to $24.5 billion, while YouTube ad revenue surged 33.5% to $4.0 billion. (YouTube nonadvertising revenue is included in the Search and other category.)

For total ad revenue context, in the third and fourth quarters of 2019, this metric rose 17.1% and 16.7%, respectively, year over year.   

Growth in Cloud and YouTube ads was impressive. 

Adjusted operating income fell 3.9%

Operating income based on generally accepted accounting principles (GAAP) grew 20.7% year over year to $8.0 billion. But excluding the year-ago period's European Commission (EC) fine of $1.7 billion, operating income declined 3.9% year over year. (As to the fine, the EC alleged that "certain contractual provisions in agreements that Google had with AdSense for Search partners infringed European competition law," Alphabet said at the time.)

The Google segment's operating income came in at $9.3 billion, up nearly 1% from the year-ago period's adjusted operating income (which excludes the EC fine). Other bets' operating loss widened 29.1% to $1.1 billion.

Adjusted operating margin shrank to 19% from 23% in the year-ago quarter because costs continue to rise faster than revenue. 

Adjusted EPS dropped 17.1%

Net income landed at $6.8 billion, down 18% from the first quarter of last year when we exclude that quarter's $1.7 billion EC fine. That translated to adjusted earnings per share of $9.87, down 17.1% year over year. Wall Street was looking for adjusted EPS of $10.38, so the company fell short of the analyst consensus estimate.

Operating cash flow fell 4.6%

Alphabet's operating cash flow was $11.5 billion, down 4.6% from the prior year's quarter.  

The company ended the period with cash and cash equivalents on its balance sheet of $19.6 billion, up from $19.1 billion in the year-ago period.

Not as bad as expected

In short, Alphabet's results were significantly hurt by decreased ad spending stemming from the pandemic. Keep in mind that the results don't look terrible because it wasn't until the end of the quarter (mid-March) that the World Health Organization declared that the COVID-19 epidemic was a pandemic, which was followed by most U.S. states and many other countries issuing stay-at-home orders.

It seems extremely likely that investors are going to see greater pandemic-driven damage to Alphabet's second-quarter results.

I think the market overreacted somewhat too positively by driving shares up nearly 8% after hours on Tuesday. Long term, sure, Alphabet is going to be fine, but there could be much pain ahead.