Tech

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

Wall Street freaked out about Google's parent company on Thursday. The company needs a stint in the doghouse as punishment, but investors shouldn't lose focus on the essential health of Google's advertising business. 

Understandably, stock jockeys are quick to pounce on companies with $500 billion market values that fall short of their expectations. Alphabet fell a tad shy of analysts' average estimates for revenue and whiffed badly on the outlook for profits under nonconventional accounting. Its shares dipped 6 percent in after-hours trading, wiping away about $32 billion in stock value.

Movin' On Up
Google's revenue is on track to triple since since 2010
Source: Bloomberg and RBC (for estimated 2016 revenue)

Nothing terrible happened. It was a tale of a few bobbles here and there that compounded into a giant eraser rubbing out some market value. Ad sales were a touch light. Money spent on the company's research and development efforts rose faster than revenue growth. The "speculative bet" companies turned in a much wider operating loss as those moonshots continue to suck up Google's funds. 

But it's wise not to lose sight of the incredible growth and profit machine of Google's parent company. Alphabet's first-quarter revenue growth rate of 17.4 percent was better than all but two U.S. companies with at least $25 billion in revenue during the last 12 months.

For the curious, those two are Amazon and Cardinal Health, with sales growth in their most recent quarter of 22 percent and 21 percent, respectively, according to an analysis of Bloomberg data. Both of those companies don't come anywhere close to Alphabet's operating profit margin of 26 percent.

The bad marks on the earnings report card are a little worrying for Alphabet. The company in the last year has managed to convince investors it actually cares what they think. The company -- with a CFO hired from Wall Street -- promised it found expense control religion. Warm fuzzy feelings ensued, and the company's valuation soared. 

Alphabet Surge
Until Thursday's earnings report, Alphabet's 47 percent stock jump since the beginning of 2015 had pushed the company's valuation above that of the Nasdaq index
Source: Bloomberg
Note: Valuation reflects share price as a multiple of expected earnings, excluding some items, for the next 12 months.

The executive team at Alphabet now has to do a mop-up job to convince investors it won't disappoint them so badly again. Alphabet management explained on the earnings call that the shift of Internet use to smartphones is weighing on profits. Ad prices on smartphones and fast-growing areas such as YouTube tend to be cheaper than those of more mature spots on the Web. Industry changes in how advertising is sold online is driving up Google's payments to ad partners. 

Even with a quarterly miss under its belt, Google confirmed on Thursday that it remains the Internet's best business model. Paid ad clicks -- the core element of Google's revenue generation -- rose 29 percent in the first quarter compared with those in the period a year earlier. In the last six months, that essential metric has been perking up, although it has been easier to show good numbers coming off a fallow period for paid clicks. It's a sign that Google's Web search and other ad businesses are holding up. More concerning was a 9 percent drop in the average price advertisers pay each time people click on Google ads. 

Click Power
Even at the huge size of Google's Web empire, the company continues to sharply increase the number of ads it sells. But the average cost of each ad continues to fall.
Source: Alphabet

Earnings misses do have implications for the thesis behind Alphabet, billed as a way to keep Google's ad machine churning while allowing freedom to teams pursuing "moonshots" that might turn out to be real businesses. Clothing made from electrical thread? Wind turbines that fly like propeller planes? Troubled startups that make terrifying robotic Santas? Sure!

As long as Google keeps being Google, no one cares about those dreamers at Alphabet responsible for operating losses of $3.6 billion last year. The grown-up parts of Google can laugh, point to the towering piles of money their businesses generate and taunt those Alphabet types with lame memes.

That's why those crazy moonshot kids should care about how Google does. The growth and profits have to keep coming, or else mom and dad are going to cut off their allowance. Google did well enough this time to keep the parents off their backs. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

  1. The analysis excluded a handful of companies -- Kraft, UnitedHealth and AT&T -- whose most recent quarterly revenue growth rates were inflated by large acquisitions. The growth rate figures for Amazon and Cardinal Health were for the three months ended Dec. 31. 

To contact the author of this story:
Shira Ovide in New York at sovide@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net