Alphabet (NASDAQ:GOOGL) (NASDAQ:GOOG), the company behind Google’s ubiquitous search engine, generated another expectation-beating quarter to extend its track record of consistent revenue growth. The stock fell about 3% after hours in the wake of the company’s earnings report, however, as concerns about higher costs, lower operating margins, and capital expenditures gave investors pause.
At first glance, these costs might seem like an area of concern, but digging a little deeper shows that just isn’t the case. Let’s examine why investors should actually be happy about many of these costs.
Image source: Google.
A closer look
For the fourth quarter, Alphabet delivered revenue of $39.3, up 22% year over year. Operating income of $8.2 billion jumped 21% from the year-ago quarter, resulting in diluted earnings per share (EPS) of $12.77, up 12% year over year. Both revenue and EPS exceeded analysts’ consensus estimates.
One thing that’s consistently concerned Alphabet investors is escalating traffic acquisition costs (TAC), or what Google pays other companies for directing users to its search. TAC grew to $7.4 billion, or 23% of Google’s total ad revenue, edging lower from a 24% mark in the prior-year quarter. This cost has trended upward over the past several years, but search remains the funnel that feeds Google’s all-important advertising.
Other costs of revenue (everything not TAC-related) totaled $10.5 billion, up 34% year over year. This performance was driven by content acquisition costs for YouTube, which is one of the fastest-growing segments of the company’s advertising business, in its seasonally strong quarter. Spending in this category also helped support the platform’s relatively new subscription services, YouTube Premium and YouTube TV.
Another area of interest is the declining rate of cost per click, or how much money Google makes on each ad. That rate fell by 29% year over year, but that requires perspective. Advertising on mobile and YouTube is less lucrative than ads that appear on Google’s desktop search, but the number of ads is growing much more quickly on these other platforms. The result is a declining cost-per-click rate that adds pressure on the company’s operating margin — but it also pushes revenue higher.
You have to spend money to make money
The theme of “ongoing investment” was reiterated throughout the quarterly conference call. We find one such example in Alphabet’s capital expenditures, which grew to more than $7 billion in the fourth quarter, a 64% year-over-year increase. “We continue to invest in both compute requirements and for office facilities,” Alphabet CFO Ruth Porat said. Google plans to expand not only the number of its data centers but also the headcount necessary to support its fast-growing cloud computing operations — which also tends to increase research and development expenses.
The company rarely provides specific metrics for its cloud computing operations. This time last year, Alphabet CEO Sundar Pichai said Google Cloud was “already a $1 billion-per-quarter business.”
The company didn’t detail cloud revenue for the fourth quarter, but Pichai said it continues to be “one of the fastest-growing businesses across Alphabet.” Pichai added that Google Cloud doubled both the number of deals over $1 million and the number of multi-year contracts, and it surpassed 5 million paying customers for G-Suite, the platform’s collaboration solution for businesses.
Not merely spending, but investing
Investors willing to expand their view will see that while higher spending is contracting Alphabet’s margins, these costs represent investments in the company’s future. They’re the type of costs that are arguably necessary to maintain Alphabet’s trend of ongoing revenue growth.
Although its stock fell in the wake of the company’s earnings report, Alphabet is doing just fine.