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This Is What’s Driving Alphabet’s Valuations

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What drove Alphabet’s profit margins in the first half of the year?

Alphabet’s (GOOG) revenue rose 26% to $63.8 billion in the first half of 2018. The Google segment made up 100% of revenue for the first half of 2017 and the first half of 2018. Google’s advertising revenue generated 86%–87% of revenue for both halves. The United States accounted for 46%–47% of revenue in both halves. The EMEA, APAC, and other Americas accounted for 33%, 15%, and 5%–6% of revenue, respectively.

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Alphabet’s cost of revenue increased 36% in the first half of 2018 to $27.4 billion. Its cost of revenue margin rose from 40% in the first half of 2017 to 43% in the first half of 2018. Traffic acquisition costs (or TAC) accounted for 23% of its advertising revenue in the first half of 2018. Thus, its gross profit increased 19% to $36.5 billion in the first half of 2018. Its gross margin declined from 60% in the first half of 2017 to 57% in the first half of 2018.

Operating expenses rose 26% to $21.6 billion in the first half of 2018. Research and development expenses and sales and marketing expenses drove those expenses. Expenditures consumed 34% of revenue in both the first half of 2017 and the first half of 2018. Thus, income from operations improved 11% in the first half of 2018 to $14.9 billion. Its operating margin decreased from 26% in the first half of 2017 to 23% in the first half of 2018.

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Google’s Android was fined $5.1 billion by the European Commission in July 2018 for infringement of the law. Google’s net income increased 71% to $15.3 billion in the first half of 2018. Its net margin grew from 18% in the first half of 2017 to 24% in the first half of 2018. Its EPS improved 70% to $21.70 in the first half of 2018.

The latest developments driving Alphabet’s valuations

Alphabet announced a partnership with China’s leading e-commerce company JD.com (JD) in June. It plans to invest $550 million in JD.com under the alliance and gain access to China, where the search engine market is led by Baidu (BIDU) with a market share of 78%. Alphabet will utilize the JD.com association to compete with Amazon (AMZN) in the product searches domain.

Alphabet last traded at a 7% discount to its 52-week high. The stock has gained 13.4% year-to-date. Alphabet’s revenue projections for fiscal 2018, 2019, and 2020 are $137.1 billion, $163.6 billion, and $191.6 billion, respectively. Analysts have projected EPS of $39.50, $48, and $56.40, respectively, for those years. That translates to expected PE ratios of 30.1x, 24.7x, and 21.1x, respectively, for those years. The stock has a “strong buy” recommendation from two analysts and a “buy” recommendation from three.

In the next and final part of this series, we’ll look at Baidu’s performance in the first six months of 2018.

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