Alphabet earnings leap but costs surge

Alphabet Q2 earnings out last night didn't put to sleep valuation concerns that have weighed on its shares for weeks.

Alphabet earnings leap but costs surge

Alphabet Q2 earnings out last night didn't put to sleep valuation concerns that have weighed on its shares for weeks.

The owner of search giant Google comfortably beat top and bottom line forecasts with a 21% rise in revenues to $26bn and EPS of $5.01 against expectations of $4.46 and $25.65bn but the shares, having closed a little higher, fell around 3% in after-hours trading.

EU pain

Earnings would have sparkled more were it not for the impact of the $2.7bn fine levied by the EU in the quarter, on allegations that Google show results that unfairly discriminate against other advertisers. Alphabet is still deciding whether to appeal, but it took a charge for the penalty nonetheless, and this hit the bottom line. That contributed to a 28% net income decline compared to Q2 2016, leaving profits of $3.5bn. A likely profit  fall was flagged by the group well in advance, so whilst a hit to sentiment, other negatives are likely to drag Alphabet shares in Tuesday’s main market trading.

CPCs down as PCs phase-out

For these, we look to the latest in a string of warnings by the group that expenses will not find a baseline until the transition of the bulk of Google searches from desktop to handheld devices is complete. A rise of traffic acquisition costs goes hand in hand with the journey. Rising mobile traffic also equates to higher virtual footfall via third-party channels (like apps) with commensurate pressure on margins. Cost of revenue—which Alphabet uses to describe running costs before capital expenditure on things like research, rose 28%, increasing faster than top-line growth. The group reiterated that it expected a similar pattern to prevail for the foreseeable future. "As we've often said, we're focused on revenue and operating income dollar growth and not on operating margins," CFO Ruth Porat said.  Looked at another way, investor disquiet grew after what remains the group’s most highest-revenue business—search advertising, worth almost 90% of revenue—saw costs to advertisers fall 23% in Q2. That shaved value off a 52% rise in aggregate paid clicks.

A spirit of anti-trust

With already restive investors faced with these cracks in an otherwise strong quarter it was helpful that other frequent sources of controversy in Alphabet results eased. Product revenues, including from Pixel smartphones, Play Store and cloud, rose 42.3% to $3.09bn, slightly exceeding forecasts and beginning to assure Wall St. that Alphabet’s efforts to bolster non-search businesses are gaining traction. Losses from ‘other bets’—including long-run and moon-shot projects like Waymo self-driving cars and The Google X Project Wing—narrowed to $772m from $855m.

Unfortunately though, an increasingly aggressive anti-trust spirit abroad is perhaps the biggest elephant in the room right now for Alphabet and fellow technology gargantuans like Amazon, Facebook and Apple. And it’s not just abroad in regions like Europe—investors reason that these ‘tax-efficient’ and nimble giants may look like low-hanging fruit to a U.S. administration that’s high on rhetoric about American jobs, and low on achievements so far on Capitol Hill.  The lack of commentary from Alphabet on Monday night about expected top-line impact in the EU in the wake of the fine there and competition concerns more broadly, threaten to pause the stock’s 26% rise so far this year. Bargain hunters have frequently swooped in to buy recent corrections by FAANG shares like Alphabet, Amazon and Netflix, hoping to get aboard their long-range growth stories. But after a palpable dip in June as the blue-chip U.S. technology sector approached new all-time highs, the pattern has looked less reliable.

  • One might expect a degree of investor ambivalence to also be reflected in the technical chart of Alphabet’s A class stock. In fact, the chart paints a more promising picture for the short-term price outlook than implied by fundamentals
  • Factors of most interest to GOOGL bulls right now:
  1. the proximity to the psychological price of $1,000
  2. the breakout in May topside of the asymmetrical channel—despite a severe test of the impulse along with the rest of the sector in June
  3. A favourable reading of momentum in the relative strength index (RSI) sub-chart. It has seen big incursions beyond the nominal ‘overbought’ boundary of 80 for at least two years
  • In short, the chart does not indicate a marked decline of buying interest over the short term
  • That said, resistance comprised of the record high of $1008.6 on 6th June is also clear enough
  • GOOGL, like fellow FAANG shares has mapped out an AB/CD pattern since its latest peak and the Fibonacci retracements have been wider than those generally regarded as normative. (A completed AB/CD pattern as the share returns to record highs could be seen as a ‘sell signal’)
  • The occurrence of the fractal across several assets and so close to clear resistances is worth particular caution, as is the essential divergence of the RSI since mid-April against the stock’s attempts to sustain a clear up leg
  • With the upper line of the rising channel now invalidated, trend support on the way down may be wanting
  • Any down move might be exacerbated should it reach the $893-$915 gap, which sellers will almost certainly to attempt fill

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