Google Smashes Expectations but Declining Ad Prices and Soaring Costs Smash Stock

By many measures, Alphabet Inc. (NASDAQ:GOOGL) was a juggernaut during the fourth quarter. Google’s parent company rang in the 2019 year having earned $12.77 per share on net revenue of $31.77 billion over the previous three months. Both figures beat estimates.

By other measures it was a quarter that conjured up investor fear for what future revenue and earnings might look like. Google’s rising costs and weakening ad pricing power spooked investors enough that its high-priced shares dropped by 3% following Alphabet Inc. (NASDAQ:GOOGL)’s February 4 earnings report. They haven’t regained any momentum since.

Meir Barak, founder of Tradenet, adds: “Now, mid February 2019, that Nasdaq is finally out of bear territory, we’d be able to see what trajectory Alphabet stock takes. One of the top five companies in terms of market cap, the Google parent company never sees its stock trailing too far behind the Nasdaq index.” Barak’s Tradenet Day Trading Academy offers a range of courses on technical analysis and a YouTubeTrading  Channel where he explains some aspects of technical analysis and conducts daily live streams of his trading.

Google Inc (NASDAQ:GOOG)

Alphabet Inc. (NASDAQ:GOOGL) and the Nasdaq index were sitting on equal gains year-to-date just a week ago. The Nasdaq has now opened a nearly 3.5% gap on the year. Market sentiment is mixed right now and could swing either way on the latest developments. A bombshell U.S/China trade deal coming together would certainly ignite the markets and would likely send Alphabet careening along behind the Nasdaq.

Until then, investors will be looking for signs of which direction Alphabet is headed in terms of its various worrisome Q4 signals.

Costs Rise as Google Pushes Cloud Expansion

Google’s costs rose heavily on two fronts during Q4: cloud computing and traffic acquisition costs (TAC). Alphabet’s TAC hit $7.43 billion during Q4, nearly a $1 billion increase from a year earlier. The market was actually expecting worse news, predicting $7.63 billion. Those costs aren’t getting any cheaper. Apple could raise its TAC fees on Google by 33% in 2019, to $12 billion, according to a Goldman Sachs forecast.

As for cloud, it’s a segment the company has begun aggressively building and remains one of its fastest growing units according to management (though they declined to provide revenue figures). Alphabet’s employee headcount has risen to nearly 99,000 as of the end of 2018, up from 80,000 a year earlier. That growth took place primarily in the cloud division according to CFO Ruth Porat on the Q4 conference call.

Google is increasingly turning to contract workers to offset the costs of its growing workforce. Over half of that workforce consisted of contract workers by the middle of last year, topping 50% for the first time. In addition to cutting costs, temporary hires skirt Google’s lengthy hiring process for direct employees, which can take months. For projects with imminent holes to be plugged, it’s a far more convenient option for the tech giant.

Google’s CPC Rates Dive in 2018

Just in case Apple gouging it through the eyeballs wasn’t enough, Google also has to contend with its own ad rates plummeting last year. Perhaps they need to hire away Apple’s contract negotiator. Google’s cost per click rates fell by 29% last year, including by 9% during the holiday quarter.

Alphabet’s YouTube ad rates are also being threatened by a pedophilia scandal that has galvanized advertisers. Several major YouTube ad buyers like The Walt Disney Company (NYSE:DIS), Epic Games, and Grammarly have put a halt to their current ad campaigns.

As we’ve seen with Google’s CPC rates, having a monopoly in your industry doesn’t mean you have complete pricing control. However, it’s not the first scandal of this nature to engulf YouTube and won’t be the last. YouTube’s only real competition in video is Facebook, which has about two-thirds of the reach and just as many problems.

Alphabet’s “Other Bets” Aren’t Paying Off Yet

The collection of odd little companies housed in Alphabet’s “Other Bets” segment is starting to be a big-time drain on the $775 billion holding company’s financial results. The little unit, which includes Google’s self-driving car subsidiary Waymo, managed a modest $154 million in revenue in Q4. That was an 18% year-over-year increase but wasn’t even close to the $187 million estimates.

Far worse was the operating loss of $1.3 billion generated by some of its many members. Among them are health unit Verily, drone delivery unit Wing, and internet balloon unit Loon. There is optimism that Waymo monetization will start to ramp up and Loon struck its first deal this year, selling its custom software to Canadian satellite company Telesat.

The huge operating loss from “Other Bets” pushed Alphabet’s Q4 operating margins down to 21% from 24% a year earlier. And the $8.2 billion in operating income even came with its own caveat: that $1.3 billion of it was from unrealized gain on an investment.

All told, there was a lot bubbling beneath Google’s strong facade of revenue and earnings figures in Q4, and much of it wasn’t great. Whether some of those trends persist or reverse will determine much of the stock’s success in 2019.

Disclosure: None. This article is originally published at Insider Monkey.