One of the many things that Alphabet (NASDAQ:GOOGL) has going for it is its great collection of seemingly disparate businesses. From consumer products and self-driving cars to various apps, Alphabet has a lot of different ways to make money. But its the hefty advertising business that’s fueling GOOGL stock and funding those other businesses.
The problem is, a few cracks are starting to develop in Alphabet’s advertising armor.
Despite the growth last quarter in advertising, GOOGL is facing some fierce competition from rivals. The slog is getting harder. For Alphabet stock investors, these outside forces can’t be ignored. The road is going to get a bit tougher. Despite a 7.7% gain in 2019, the shares have lagged the Nasdaq Composite index‘s 13.8% increase this year.
Great Numbers Report With a Big Asterisk
Alphabet gets a lot of press for its forays into self-driving cars and high-speed internet access, but the heart of GOOGL’s empire is still search. And more accurately, selling ads based on that search data. AdWords — which uses auctions to buy text-based ads on websites — and AdSense, which publishes ads on third-party websites, combined produce the lion’s share of Alphabet’s revenues. Maps, YouTube and other applications are now starting to help generate some serious advertising dollars as well.
GOOGL’s recent fourth quarter and full-year results are a testament to this fact. The tech giant managed to record a whopping $32.6 billion in ad sales during Q4. Moreover, over the full year, Alphabet managed to see sales hit a record $136.8 billion. That number was primarily driven by continued ad sales, which makes up around 83% of its total revenue.
And it’s easy to get excited about those figures when you look at Alphabet’s growth. Quarter-over-quarter, ad sales jumped more than 20%, while year-over-year, GOOGL saw a 22% jump in its revenue. As fellow InvestorPlace contributor, Laura Hoy put it, “one billion plus people are going to be searching, reading email, buying apps and getting directions through Google. Advertisers simply can’t ignore that kind of reach.”
Except, they sort of have.
Those big gains in ad sales are coming with a big asterisk. That’s because Alphabet isn’t making as much money per ad/click as it once was. Cost per click (CPC) is a common method that many websites use to bill based on the number of times a visitor clicks on an advertisement. Google AdWords/AdSense use this method through a series of real-time auctions and algorithms. The issue is, GOOGL’s cost per click rates are declining in a big way.
Last quarter, the cost-per-click rate declined 29% year-over-year. Sequentially, the firm’s cost per click sank 9%. During the third quarter, GOOGL also saw a 28% year-over-year decline. These are some of their worst cost-per-click figures since 2015. So, while, Alphabet saw immense growth in the number of clicks and ads sold, it’s only getting pennies for them now.
Biggest Threats Become Real for Alphabet
Why only pennies? The reason is simple. Advertisers now have a plethora of options for their budgets. Google used to be the only game in town, but not anymore.
For example, paid sponsor and advertising placements on Amazon (NASDAQ:AMZN) seem to have a better ROI. As a result, more advertisers are flocking to AMZN over GOOGL. Research firm eMarketer now predicts that Amazon will grow its advertising business by 50% this year to claim roughly 8.8% of U.S. digital ad spending in 2019, reaching 10% in 2020. Google, on the other hand, is expected to lose 1 point of market share.
And the paring could happen faster if the firm is not careful.
For example, Alphabet gets advertising revenue from paid search on mobile devices through its deals with Apple (NASDAQ:AAPL) and on its own Android operating system. However, lately, device makers are looking to step away from the relationship and take more control themselves.
In its latest Galaxy S10 phone, Samsung has designed its own camera app that bypasses the stock app that Google provides with Android. The app has Facebook (NYSE:FB) integration built in. The Galaxy line is one of the most popular Android phones out there. This sort of direct integration won’t be ignored by advertisers. Nor will the be the growth of Amazon’s Alexa software now coming preinstalled on some phone models.
Meanwhile, Walmart (NYSE:WMT) is reported to be bringing its digital ad business in-house to challenge for more of brands’ marketing budgets, according to the Wall Street Journal.
Walmart also plans to bring its store and digital ad teams closer together, using Walmart’s vast trove of shopper data to sell marketing opportunities in more parts of its sprawling business, including Vudu, its video streaming service.
The point is, advertisers have a lot more choice where to spend their dollars and that continues to hurt GOOGL. Think of it this way, when oil prices are low, energy companies have to sell a bunch more barrels to make the same dollar amount. That’s what’s happening at Alphabet. The hope is that it can still grow those “barrels” as well in the face of new competition.
Final Thoughts on Alphabet Stock
Is GOOGL stock in danger of falling into the abyss, becoming a relic like so many dot-com stocks? No, not at all. But the advertising declines are a troubling and increased competition in the ad space means that Alphabet is going to have a harder time getting the revenues it needs. That could affect its other businesses as well. It’s just something to think about when looking at Alphabet stock. GOOGL may not be the fast grower that we think it is.
Disclosure: At the time of writing, Aaron Levitt was long AMZN.