Key Takeaways

  • Alphabet's EPS was $10.21 vs. the $7.92 analysts expected.
  • Quarterly revenue beat expectations but declined year-over-year for the first time in the company's history.
  • Traffic acquisition costs exceeded estimates.
  • Alphabet reported unadjusted EPS this quarter, while it reported adjusted earnings last quarter.

What Happened

Alphabet reported its first ever quarterly year-over-year decline. Despite this company first, both revenue and EPS declined by less than expected as advertisers tightened their belts due to the pandemic's disruption of the economy. Traffic acquisition costs came in higher than analysts expected. Alphabet instituted a hiring freeze and cut marketing spending in half for the second half of the year. Shares of GOOGL were up slightly in after-hours trading.

(Below is Investopedia's original earnings preview, published July 23, 2020)

What to Look For

Alphabet Inc. (GOOGL), parent of search giant Google, enjoyed robust gains in revenue, profits, advertising and online traffic earlier this year amid spreading government lockdowns and the global recession brought about by COVID-19. Investors will want to know whether Alphabet can capitalize on those gains, especially the spike in Internet traffic, when the company reports Q2 FY 2020 earnings after market close on July 30.

Q2 will be the first quarter to fully encompass Alphabet's performance during the pandemic, and analysts indicate that most of the news won't be good. They forecast a dip in revenue and plunging adjusted EPS compared to the same period a year ago.

Investors will pay particular attention to a key metric: traffic acquisition costs (TAC), a measure of how much the company pays to pull people into their sites. Rising or high traffic acquisition costs indicates lower margins and profits. That may mean good news for Alphabet in Q2 FY 2020 because analysts estimate that TAC will fall (YOY). Investopedia is focusing on TAC because Alphabet no longer includes the YOY percent change in paid clicks in its earnings press release.

Alphabet has outperformed in the past 12 months, posting a total return of 37.4% compared to the S&P 500's total return of 9.8%.

One Year Total Return of S&P 500 and Alphabet
Source: TradingView.

In Q1 FY 2020, adjusted EPS came in below analysts' expectations, but strong EPS and revenue growth still sent Alphabet stock surging in the following months. Adjusted EPS rose 21.7% on a 12.8% increase in revenue. Alphabet's adjusted EPS generally has been volatile, showing wide swings in performance and declining in two of the past five quarters since Q1 FY 2019. Now, for Q2 FY 2020, investors predict EPS will fall by 34.9% YOY. 

By contrast, Alphabet's revenue has seen steady YOY increases in each quarter for nearly four years. In recent Q2 periods, this increase has ranged from 19.3% year-over-year in Q2 FY 2019 to 25.6% in Q2 FY 2018. Even with the initial impact of the COVID-19 pandemic, the company saw YOY quarterly revenue increase by 12.8% in Q1 FY 2020. For Q2 FY 2020, analyst expect that revenue to fall by 4.2% to $37.3 billion.

Alphabet Key Metrics
  Estimate for Q2 2020 (FY) Actual for Q2 2019 (FY) Actual for Q2 2018 (FY)
Adjusted Earnings Per Share ($) 11.23 17.25 11.75
Revenue ($B) 37.3 38.9 32.7
YOY Growth in Traffic Acquisition Costs (%) -8.2 12.7 26.1

Source: Visible Alpha

As mentioned, investors also are likely to focus on Alphabet's traffic acquisition costs, a key expenditure for Internet companies. This metric reflects how much the company has to pay to affiliates in order to direct or draw traffic to its sites. TAC is a critical measure of cost of revenue for Alphabet, and the higher these costs are, the lower Alphabet's margin is once it has generated money by selling ads to the viewers it has drawn. If TAC increases year over year for a company, it can negatively impact profit margins longterm. Alphabet historically has cited rising TAC as one of the "Risk Factors" for investors to consider.

Alphabet's TAC generally has more than doubled from $4.2 billion in Q3 FY 2016 to $8.5 billion in Q4 FY 2019. Now, analysts estimate that traffic acquisition costs will drop 8.2% YOY in Q2 FY 2020. That would be the first decline in TAC in at last 16 quarters. This may indicate that the company is paying less for its traffic at a time when traffic volume may in fact be increasing. Given analysts' bearish forecasts for falling revenue and profit, this could represent a bit of good news for Alphabet during a challenging time.