Alphabet (GOOGL) reported weaker-than-anticipated third-quarter results Tuesday evening on the back of a strong U.S. dollar and a slowdown in advertising spending. The stock sank ~5% after hours. 

• Total revenue of $69.1 billion represented a year-over-year increase of about 6%, but missed analysts’ estimates of $70.58 billion, according to Refinitiv. The strong dollar was a 5-percentage point headwind to revenue growth, meaning revenues increased 11% on a constant-currency basis, the company said.

• Adjusted earnings-per-share fell by more than 24% year-over-year, to $1.06 a share, well below the Wall Street consensus estimate of $1.25 a share, Refinitiv data showed.

Revenue breakdown

Google Advertising revenue increased 2.5% year-over-year, to $54.48 billion, missing the consensus estimate of $56.59 billion. Broadly speaking, revenue growth slowed due to difficult year-over-year comparables, as well as an additional headwind from a pullback in advertising spending.

• Google Search & Other revenue rose 4%, to $39.54 billion, below the $40.93 billion forecasted by analysts, driven by a solid performance in travel and retail. Tough comparables annually weighed on the growth rate, but management admitted there was a pullback in spend by some advertisers in certain segments and search ads. Financial Services is one area that saw a decline, most notably in the insurance, loan, mortgage, and crypto subcategories. Given the sharp rise in mortgage rates and the spectacular decline in crypto, this is to be understood. 

• YouTube Ads revenue unexpectedly fell about 2%, to $7.07 billion, a big miss versus the $7.42 billion predicted by analysts. Google Network revenue dipped 4.6%, to $7.87 billion, missing the consensus estimate of $8.23 billion. Both businesses experienced a greater pullback in spend by some advertisers compared to the second quarter. 

Google Other revenue increased 2% year-over-year, to $6.87 billion, beating analysts’ forecasts of $6.72 billion.

Google Cloud revenue increased 38% year-over-year, to $6.9 billion, ahead of a $6.69 billion consensus estimate.

In Other Bets, which represents some of Alphabet’s “moonshot” projects like the autonomous driving company Waymo, revenue increased by $27 million year-over-year, to $209 million, roughly in in line with analysts’ estimates of $208 million.

P&L breakdown

As for profitability, Alphabet reported an operating profit of $17.135 billion in the third quarter, well behind analysts’ expectations for $19.647 billion.

•  Google Services made $19.78 billion, compared with the consensus estimate of $23.27 billion, squeezing the operating margin to 32% from 40% a year ago.

• Google Cloud lost $699 million, a beat versus estimates of a $732 million loss and comparable to a $644 million loss a year ago (on lower revenues).

• Other Bets saw a $1.61 billion loss, steeper than the $1.55 billion loss predicted by analysts and the $1.29 billion loss incurred last year.

Other results

Operating Cash Flow was $23.35 billion, missing expectations of $24.54 billion. Free Cash Flow came in at $16.077 billion, below the $18.82 billion predicted by analysts.

Alphabet spent $15.4 billion on share repurchases in the third quarter.

One way companies can protect earnings in a growth slowdown is by moderating capital expenditures (capex). We saw capex slow slightly in third quarter, coming in around $7.28 billion, below estimates of $7.62 billion. But Alphabet’s headcount continued to grow, increasing to 186,799 at the end of September from 174,014 at the end of June. More than 2,600 of the additions were related to Alphabet’s acquisition of cybersecurity firm Mandiant.

Outlook comments

• Alphabet expects an even larger headwind from foreign exchange in the fourth quarter due to the strengthening U.S. dollar.

• Tough comparables will continue to weigh on the year-over-year rates of advertising revenues.

• A decline in user engagement and gaming from the elevated Covid-19 pandemic levels will continue to be a headwind to advertising revenue, with lower revenues from app promo spend on YouTube, Network, and Play ads in Search.

• Management remains excited about the long-term prospects of Google Cloud and will continue to invest in the business despite current losses.

• Fourth-quarter headcount additions are expected to slow to less than half the 12,765 added in the third quarter. Management’s actions to slow the pace of hiring should be more apparent next year.

Bottom line

This was a poor set of quarterly results from Alphabet, as the strong U.S. dollar and a pullback in some advertising spending resulted in one of the slowest revenue-growth rates the company has seen in years. Even Google Search, the greatest advertising platform in the world, was not immune to some macroeconomic pressures.

Although Alphabet can’t control how much advertisers are willing to spend, one piece of good news is management’s commitment to managing expenses by driving efficiencies and moderating new headcount in 2023. This should slow the degradation of margins in this tough economic environment.

Still, what management does to protect earnings won’t help with the slowdown Alphabet is seeing in its business. What this likely means is that the tech giant will go through another round of downward earnings- and price target revisions over the next few days, weighing on the stock.