Google drives a strong quarter for Alphabet
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Google drives a strong quarter for Alphabet

Alphabet’s fourth quarter earnings release last week made two things abundantly clear: first, when it comes to revenue, Google is still overwhelmingly the engine in Alphabet’s car; and second, it’s one hell of an engine.

Alphabet/Google’s quarterly revenue continues its upward trend

SOURCE: Quartz Media

Last quarter, the company generated $26 billion revenue – that’s up 22% from the same period a year ago – against expectations of $25 billion from Wall Street. Chief financial officer, Ruth Porat, was quick to describe this growth as “Exceptional,” and said: “this performance was led by mobile search and YouTube.”

She is right that it’s exceptional performance, no matter how you look at it. 22% growth for a company Alphabet’s size is phenomenal; beating analysts’ estimates on revenue by a billion dollars is incredible. Yet somehow, investors don’t seem to be too impressed.

Alphabet’s stock reacts to Q4 2016 earnings

SOURCE: Quartz Media

Alphabet’s share price dropped by 1% shortly after the company released its quarterly earnings. This is bizarre, true, but it is not the first time we’ve seen the market react poorly to what seem like hugely positive earnings.

Part of the reason investors might react badly to Alphabet’s news is that their expectations have been blown out of all proportion. Alphabet is so successful that beating analysts’ expectations by a billion dollars isn’t impressive enough for investors. It’s so successful that delivering 22% revenue growth against the previous year – even though it is already the second largest company in the world by market cap – isn’t impressive enough for investors. This is ridiculous, of course, but it’s not unique; other companies – most famously Apple – have been penalized by the market for the same thing.

Another reason that investors might be feeling lukewarm about Alphabet’s latest earnings report is the extent to which Google is responsible for the company’s success. Google made up an incredible 99%, roughly, of revenue earned by Alphabet this quarter.

Alphabet is still dominated by Google

SOURCE: Quartz Media

It’s understandable that investors wouldn’t regard this situation as ideal, but it shouldn’t surprise them. For a start, it’s important to have a sensible estimation of Google’s place in the market: it’s the most popular search engine in most of the world, and it achieved that position by being legitimately better than its competitors. That doesn’t look like it’s changing anytime soon – Google is, more or less, the door through which all internet users walk to go online. That’s an incredibly powerful position to hold.

It’s also true that Google’s product isn’t ageing in the way that, say, Apple’s iPhone is. Apple has dominated the smartphone market for an enviable amount of time, but that market’s reaching saturation, and the company’s rivals are finding new innovations to make their handsets attractive. None of that’s true with Google: it’s still by far the best web search service, and – despite Google’s size – a significant portion of the world is not yet online.

That means, there are billions of new internet users scheduled to come online in the next decade and, the way the internet is set up right now, they’re almost all going to be using Google.

Google’s also got some handy tricks up its sleeve: YouTube, which remains exceptionally popular across multiple demographics of internet user, and a whole suite of branded services (like Gmail and Google Drive) that draw people into the company’s ecosystem simply by offering better services than everyone else, absolutely free.

Google is this ecosystem and, at least for the foreseeable future, it is meant to be the part of Alphabet that earns the money! Case in point: Google’s non-advertising revenue rose by 62%, roughly a billion dollars, and this has to be down (at least in part) to sales of fancy new hardware. In October last year, the company launched a barrage of attractive, self-branded products including its highly anticipated Pixel smartphone; its answer to Amazon’s Echo, and other virtual personal assistants, Home (which we profiled in the newsfeed recently); and a new-and-improved Chromecast streaming device.

What do these things have in common? They are engineered specifically to draw you into Google’s ecosystem. Like Apple (but far more so), the company’s interest in hardware is to pull you into its far more lucrative ecosystem, where things like advertising, cloud computing, artificial intelligence, and subscription-based app services all become possible. In Google’s case, this ecosystem is enormous, and growing.

Alphabet’s ‘Other Bets’ are still just a money pit

SOURCE: Quartz Media

All the other things Alphabet is into sit outside of its moneymaking quest. Whether it’s a long-view R&D project that might deliver revenue decades down the line; an initiative to achieve some lofty goal, like space travel, to the market; or charitable works. These areas of Alphabet are not unimportant: they may well be where its next great innovation comes from; they may even change the planet. Or, they might just get Google loads of free exposure, and reinforce its image as the world’s most interesting company.

Because, lets face it, there is no marketing initiative the company could have invested in that would convey ‘smart, crazy, and fascinating’ as well as their ‘other bets’ and ‘moonshots’ segments have done: Google has been at the heart of conversations about life-extension, the “singularity” (development of super-smart, self-enhancing artificial intelligence), and more over the past decade. That’s what the people who really buy into the company love; that’s Google’s brand.

But make no mistake: Google is earning all the money because it’s engineered to. And it’s doing a much better job of it than the market’s reaction would have you believe.

Dominion holds Alphabet, the parent company of Google, in its Global Trends Managed Fund. 

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