Alphabet's Second-Quarter Earnings Could Disappoint -- Here's Why

Alphabet's (GOOGL) second-quarter results could prove disappointing, just as its first-quarter earnings did.
By Siddhi Bajaj ,

The year 2016 is not panning out all that well for Google parent Alphabet (GOOGL) - Get Report .

The technology giant's missed Wall Street's expectations for its first-quarter bottom line by a sizable margin, reporting adjusted earnings per share of $7.50, versus the $7.97 analysts were expecting. Now analysts are raising concerns about the second quarter, which Alphabet will report the results for on July 28. We'll tell you what to expect. Below, we also unveil an ingenious trading methodology that makes money in both good and bad times.

The Ghost of the First Quarter

In the first quarter of 2016, Google's traffic-acquisition costs continued to increase for a third continuous quarter, according to SunTrust analyst Robert Peck, who was quoted in this Business Insider article. These include charges that Google pays to partner websites that run its ads or services, and to companies such as Apple (AAPL) - Get Report, to keep Google's search engine as the default option on its devices, the article noted.

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Distribution traffic-acquisition costs climbed higher than expected during the first quarter, at more than 33% against revenue growth of 20%, Peck noted, and the analyst expects this trend to continue.

Expectations for the Second Quarter

SunTrust has listed slowing search-revenue trends as one of the factors likely to pressure second-quarter revenue, too, according to Business Insider. Another development that would likely rock the boat is Britain's June decision to exit the European Union.

But revenue from Europe may be affected in the long term by more than just the Brexit result. After the European Commission first filed formal charges against Alphabet in April 2015 for favoring its comparison shopping service in search results, the European Union competition regulators are gearing up to issue additional formal charges against Google.

What Analysts Are Saying

In the wake of Alphabet's discouraging first-quarter results, analysts at JPMorgan (JPM) - Get Report and Stifel cut price targets for Alphabet, concerned about a slowdown in its networking business.

Elsewhere, Citigroup analysts said their own supply checks revealed sluggish growth in search marketing spending in the second quarter. The analysts also said that Alphabet's results will come in slightly below Wall Street's estimates. 

These detailed, critical comments are worth paying attention to, even though most Wall Street firms have strong buy or buy ratings on Alphabet stock, and the median 12-month price target is $904, which is 23% higher than current levels. Remember that Wall Street analysts have an interest in keeping bullish ratings on stocks out of concern for their firms' investment banking business. 

Investors would be wise to do their homework and read as much as they can about Alphabet's business prospects. Read between the lines of analysts' comments and disregard their overall ratings. If you think that Google will face continuing headwinds for some time, then avoid the stock. If you think, however, that Google will recover from its current challenges and continue to grow in the long run, then any selloff accompanying the second-quarter earnings release would be a good time to pick up shares.

Keep in mind that Alphabet now has a price-to-earnings ratio of 18.5, based on estimates of earnings for the next year. That's much lower than the forward P/Es of other tech companies such as Yahoo! (YHOO) , (66) and Facebook (FB) - Get Report(26), so Alphabet might seem like a tempting proposition despite the earnings worries.

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This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.

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