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As we reported yesterday, Alphabet released their 1Q numbers after the market close on Monday. The results beat even the loftiest of expectations, but the stock dropped after these results. Even though they beat on top-line and bottom line, there has been a shift in the mechanics of the business, which will make it less profitable long-term.
Revenue was up 26% to $31.1 billion, and then EPS was up 72% partly due to a change in accounting principles. Previously, investments in other companies were held at cost, due to the change in accounting principle they had to revalue those investments, meaning they have booked some once-off gains. One of their successful ventures is a $3 billion gain on their Uber holding, Alphabet were early investors.
Back to their long-term cost shift problem. To get people to the web pages that have Google ads, Google has to pay third parties. For example, Google will pay to put their ads on blog sites or pay Apple to use Google search in Safari. Google has what they call Traffic Acquisition Costs (TAC), this rose from 22% of revenue to 24% of revenue. The main reason for the increase is due to more people switching to mobile when they go online. Mobile TAC costs are more than desktop browsing. The impact of a higher TAC impacted their operating margin, going from 27% to 22%.
Even with TAC increasing, the company is printing cash. The business generated $11.6 billion in free cash during the quarter, driven by a 59% increase in the number of clicks on their ads. The company's 'side bets' are still rounding errors, they only generated $150 million in revenue. Unfortunately, that $150 million came with a $571 million loss, down from $703 million a year ago.
One of the main reasons we like internet stocks is because we feel that the market has underestimated the amount of growth ahead. The human mind struggles to visualise exponential growth. As it stands, less than 50% of the globe have access to the internet; Alphabet can be considered a growth stock for years to come.