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Alphabet, Inc. Shows Just How Profitable Google Really Is

By Steve Symington – Feb 2, 2016 at 5:50AM

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Alphabet's "Other Bets" are unsurprisingly losing money. But Google at its core has never been stronger.

Image source: Alphabet.

Alphabet (GOOG -0.73%) (GOOGL -0.68%) on Monday marked its first ever quarter of segment-based reporting. With shares up around 8% in after-hours trading as of this writing, investors couldn't be more pleased.

On a consolidated basis, Alphabet's revenue rose 17.8% year over year to $21.33 billion, and would have climbed an even more impressive 24% had it not been for the negative impact of foreign currency exchange. Based on generally accepted accounting principles (GAAP), that translated to 22.3% growth in operating income to $5.38 billion and 5.3% growth in net income to $4.92 billion, or $7.06 per diluted share.

On an adjusted (non-GAAP) basis -- which offers perspective by excluding items like stock-based compensation -- operating income increased 21.7% year over year to $6.82 billion, while adjusted net income jumped 29.8% to $6.04 billion. Adjusted net income per share increased 28.3% to $8.67, bolstered in part by Alphabet's decision to repurchase 2.4 million shares during the quarter for $1.8 billion. That leaves around $3.7 billion remaining under Alphabet's repurchase authorization approved last quarter.

"Our very strong revenue growth in Q4 reflects the vibrancy of our business," added Alphabet CFO Ruth Porat, "driven by mobile search as well as YouTube and programmatic advertising, all areas in which we've been investing for many years. We're excited about the opportunities we have across Google and Other Bets to use technology to improve the lives of billions of people."

Breaking it down
This shouldn't come as a big surprise, especially considering Porat's comments largely mirror those she made three months ago in crediting strength of both YouTube and mobile search for Alphabet's equally exceptional third-quarter 2015 performance.

But as I suggested in my earnings preview last week, things get much more interesting as we contrast the respective financial performances of both Google and Alphabet's "Other Bets" category. In terms of revenue and operating profit, here's what they accomplished over the past two years:

 12 months Ended Dec. 31, 201412 months Ended Dec. 31, 2015 Growth (YOY) 
Google segment revenues  $65.674 billion  $74.541 billion  13.5%
Google operating income  $19.011 billion  $23.425 billion  23.2%
Other Bets revenues  $327 million  $448 million  37%
Other Bets operating income (loss)  ($1.942 billion)  ($3.567 billion)  N/A

Data source: Alphabet.

More on "Other Bets"
So why view them on a 12-month basis? According to Porat during the subsequent conference call:

Keep in mind that Other Bets represents an aggregation of businesses, many of which operate in distinct sectors with different business models. Given their stages of development, these businesses will have idiosyncrasies with respect to the timing of revenue, expenses, and CapEx resulting from milestones, partnerships, and other factors. You can expect that results for the combined Other Bets may be uneven in the near term, so it's likely to be more instructive to look at them on an annual or rolling 12-month basis to assess their trajectory.

Nonetheless, we can see the Other Bets unit is decidedly unprofitable. But keep in mind that Other Bets is comprised of businesses like Fiber (high speed Internet), Verily (longevity), Calico (life sciences), Nest (connected home), self-driving cars, and X (moonshot initiatives) -- all early-stage efforts with massive long-term potential.

Or, as Porat put it during the call, "The majority of efforts within the Other Bets are pre-revenue."

As it stands, the majority of Other Bets' revenue comes from Nest, Fiber, and Verily. At the same time, Other Bets capital expenditures for the year primarily reflected investments in Fiber, and came out at roughly $869 million -- nearly twice the segment's total revenue, but still dwarfed by the $8.8 billion in capex dedicated to the core Google segment.

More on Google
Putting aside the bottom-line drag of Other Bets, Google over the past year boasted a solid operating margin of 31.4%, up from 28.9% in 2014. In part, that's thanks to steadily falling capital expenditures, and remains in line with Porat's encouraging assertion two quarters ago that the company will focus on "developing big opportunities [...] with great care regarding resource allocation."

As a reminder, the Google segment includes collective results from Search, Android, Maps, Chrome, YouTube, Google Play, and Gmail -- all seven of which individually boasted over one billion users during the quarter -- as well as Ads, Commerce, Apps, and Cloud and hardware products.

But the one thing many of Google's products have in common is advertising, revenue from which climbed 17% year over year to $19.08 billion. That's good for 90.1% of Alphabet's total revenue, up from 89.9% last quarter and down from 90.6% in the same year-ago period.

Within that, revenue from Google's own websites climbed 20% to $14.94 billion, and revenue from Google Network Members' sites rose 7% to $4.14 billion.

Aggregate paid clicks rose 31% year over year, driven by 40% growth in paid clicks on Google websites and a 2% increase in paid clicks on Google Network Members' sites. Aggregate cost-per-click -- which measures how much Google makes per ad -- fell 13%, including a 16% decline on Google sites and a 8% decrease from Google Network Members' sites. But to Google's credit, this is partly due to strong growth in YouTube viewership, where the platform's TrueView ads reach consumers earlier in the purchase funnel, so tend to monetize at lower rates than traditional web-based ad impressions. Still, it's an enviable problem given YouTube's superior growth.

Finally, revenue from non-advertising sources within the Google segment climbed 24% year over year to $2.1 billion, driven by strong growth from Play, Cloud, and Apps.

In the end, I'm sure there's much more digging to be done before we glean the full meaning of everything contained in Google's first segment-based report. But apart from the largely expected lack of profitability at Other Bets, there's little not to like about the Internet behemoth 's latest results.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Steve Symington has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Alphabet (A shares) and Alphabet (C shares). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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