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Search for Ad Revenue: Alphabet Looks to Build on Last Quarter’s Strength

Alphabet gets ready to report Q3 earnings this Monday with investors waiting to see if Q2’s solid performance in ad revenue continued. Other things to consider include search volume and the cloud business.

https://tickertapecdn.tdameritrade.com/assets/images/pages/md/Searching: Alphabet Google Earnings
5 min read
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Key Takeaways

  • Alphabet goes into Q3 looking to build on revenue strength seen in Q2
  • Dollar strength in focus as one possible headwind for company
  • Costs might be another aspect to watch, especially around cloud business

You could say it’s been a year of thrills and spills so far for Alphabet (GOOGL) investors.

Back in Q1, the company’s results disappointed many and the stock sank nearly 7%. Then last quarter, GOOGL just killed it on earnings, sending shares skyrocketing 10%.

Which GOOGL should investors search for as they await Q3 results this coming Monday? A lot could depend on whether revenue growth hits the levels analysts expect to see. Weaker than expected revenue driven by slowing ad sales arguably helped slam the company’s shares back in April, and better than expected revenue was one factor that came to the rescue in July.

On paper, the difference wasn’t actually that much. A 17% Q1 revenue growth figure (19% on a constant-currency basis) helped take the stock down in April, but investors seemed relieved by Q2’s 19% growth (22% constant-currency) Decelerating ad revenue appeared to spook people in Q1, as it fell nearly $1 billion short of expectations. The situation reversed in Q2 with ad revenue growth exceeding third-party consensus.

This time, analysts look for Q3 revenue of approximately $40.3 billion, up just over 19% from the same quarter a year ago. Maybe in anticipation, shares have been on a nice little run since the beginning of October. It’s been a pretty good move, though there’s potential resistance not far above the recent levels. See figure 1 below.

FIGURE 1: RESISTANCE? Shares of Alphabet (GOOGL) Jumped to about $1268 per share on last quarter's earnings, then trended downward. Since then, that's been the level to beat. Data source: Nasdaq. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

One thing that could possibly stand in the way of another solid quarter is the greenback. The company’s chief financial officer set expectations last quarter that GOOGL continues to face foreign exchange headwinds, and there’s no reason to think that’s changed, even though the dollar has retreated a bit in Q4. Next Monday, we’ll see if that had an impact on their growth.

Two-Tiered Model

When it comes to growth at GOOGL, it’s a two-headed dragon. The company has advertising from two streams, including the stream we all know in terms of Google Search. But some people forget that GOOGL also owns YouTube, and that’s also been a good source of revenue.

Advertising bounced back in Q2. Ad revenue for Q2 rose 16% year-over-year, better than the average analyst expectation and beating the 15% ad growth seen in Q1. The company said its strong Q2 results were “driven by ongoing strength in mobile search in particular, as well as YouTube and cloud.”

In a report called “Christmas Comes Early in Mountain View,” analysts at Credit Suisse said Google “posted a clean Q2” with revenue exceeding estimates across all reporting lines.

Research firm CFRA, in a post-Q2 earnings report, said it sees “continuing stability in core search, rapidly growing contribution to both top-and-bottom lines from YouTube, and, now, cloud,” among other factors. More about the cloud below.

What to Consider Watching in Q3

One of GOOGL’s key metrics is paid clicks, which show whether traffic volumes are growing. A larger audience can help offset any price reduction in ads. Last quarter, paid clicks were up 28% year over year, but down sequentially. One positive in Q2 was cost-per click, which fell 11% from a year earlier.

Also, consider watching GOOGL’s traffic acquisition costs (TAC), which are mainly what it pays companies to be the default search engine or for other ways of generating traffic to its website. Last quarter, TAC of $7.24 billion were up from $6.42 billion a year earlier.

TAC as a percentage of Google advertising revenues was slightly lower in Q2 compared to the previous year’s quarter at 22%, compared to 23% in 2018. As CNBC explained at the time, that’s a good thing, because it means the amount Google has to pay other companies to make its service the default is becoming a less significant proportion compared to its advertising revenue.

Costs are another area to consider monitoring, including hiring and YouTube as well as data centers.

Beyond that, investors might want to consider taking a look past GOOGL’s main search engine business for an idea as to how its other endeavors like cloud computing, hardware and new video streaming service Stadia are faring. Or maybe watch for what else the company may have in the pipeline, say with driverless cars or other innovations that could drive growth.

GOOGL’s other revenue category, which includes hardware like its Pixel phones and cloud products, totaled $6.18 billion in Q2, up from $4.43 billion in the comparable quarter a year earlier. The company has been talking up its Pixel 4 camera lately.

Another question some analysts have going into Q3 is how much GOOGL is spending on its cloud business as it tries to compete with Microsoft (MSFT) Azure and Amazon Web Services (AMZN), which dominate that market. Have those costs continued to increase, and is GOOGL’s cloud business still gaining ground? Last Friday, AMZN shares were taken to the woodshed after an earnings miss, mostly due to concerns from the e-commerce side, but its cloud division also fell slightly short of expectations.  

Another cloud giant—IBM—saw shares get slammed earlier this month after its Global Technology Services segment, of which cloud services is part, fell 5.6% from the year-ago period. That raised some questions about whether the weakness was isolated to IBM or a broader issue for cloud companies in general. GOOGL’s earnings could help tell the tale. 

In Q2, GOOGL touted what it called a “another strong quarter” for its cloud business, which “reached an annual run rate of $8 billion and continues to grow at a significant pace,” GOOGL CEO Sundar Pichai said in the Q2 earnings call. Pichai cited retailer Lowe’s (LOW) as a customer that had chosen GOOGL’s cloud, so maybe it’s worth scanning the Q3 transcript or listening to the call to see if GOOGL mentions any other big customers or any slowdown in that annual run rate.

You can’t discuss GOOGL’s earnings without mentioning the elephant in the room: Washington, D.C. Like other “FAANG” companies, GOOGL has been in regulators’ sights recently for a variety of issues, mainly accusations that the company engages in anti-competitive practices.

“Regulation represents the greatest risk to our investment thesis,” CFRA said in a recent note on GOOGL. “We are concerned the FTC may restrict how GOOGL can expand, especially via M&A, based on its interpretation of antitrust law. There is also the potential for new legislation aimed more explicitly at the Internet and social media giants that many U.S. legislators believe wield too much political influence and are vulnerable to manipulation.”

That said, the regulatory issues are nothing new for any of the FAANGs and for now just represent a steady background hum. They’re arguably not too relevant to GOOGL’s Q3 results.

Alphabet Earnings and Options Activity

When GOOGL releases results, it is expected to report adjusted EPS of $12.39, down from $13.06 in the prior-year quarter, on revenue of $40.32 billion, according to third-party consensus analyst estimates. That revenue would represent 19.5% growth from a year ago. 

The options market has priced in about a 4.2% stock price move in either direction around the upcoming earnings release. Implied volatility was at the 35th percentile as of Friday. 

Looking at the Nov. 1 weekly option expiration, call options have been thin, but there’s a little volume at the 1250 and 1260 strikes. Put volume is also thin, with volume heaviest at the 1235 and 1240 strikes.

Note: Call options represent the right, but not the obligation, to buy the underlying security at a predetermined price over a set period of time. Put options represent the right, but not the obligation to sell the underlying security at a predetermined price over a set period of time.

Good Trading,

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Key Takeaways

  • Alphabet goes into Q3 looking to build on revenue strength seen in Q2
  • Dollar strength in focus as one possible headwind for company
  • Costs might be another aspect to watch, especially around cloud business

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