Revenues and earnings each exceeded analysts’ expectations – EPS by 11.6%. Yet, Alphabet (Nasdaq: GOOG) (Nasdaq: GOOGL) shares sank three percent on the company’s earnings report. Why? The contrast between operational and share performance likely has a lot to do with investor confidence, or an inadequacy of it, in Alphabet’s non-core businesses. To squeeze more value out of the orange, the internet giant needs to build that confidence for investors. If accomplished, the market could look past the narrowing profit margin in its core business and reward the stock for its future prospects.
Alphabet (formerly Google) saw revenues soar 21% year-to-year in the second quarter. That is saying something, especially if we point out the absolute value of revenues at $26 billion. On a constant currency basis, revenues were up an even more impressive 23% year-over-year. However, operating margin narrowed to 16%, down from 28%. But more importantly, it narrowed to 26% when excluding the European Commission fine incurred in this year’s Q2.
That narrowing margin troubled investors because it resulted from natural industry evolution. It was due to the great migration of internet traffic to mobile platforms and also due to less profitable programmatic advertising revenues. As a result, the company’s Traffic Acquisition Cost (TAC) increased to 22% of advertising revenue, up from 21% in the prior year period.
Earnings per share was down sharply when including the fine this year, but Alphabet sharply exceeded analysts’ expectations inclusive of the hit to operations. Still, Alphabet shares were down 3% on the first day of trading after the release, despite the generally strong operating performance.
The reason for the variance in operating performance versus share price performance had a lot to do with uncertainty about the company’s future, in my view. Google’s costs and margins were impacted more than expected through its industry evolution to mobile search where profitability is…