Measuring Google's Ad Revenue Growth Runway
- By Sangara Narayanan
Alphabet (GOOG)(GOOGL), Google's parent company, is dependent on Google for its revenues, and Google is dependent on advertising for its own revenues. Despite trying hard for so many years to find an alternate revenue stream, nearly everything on which the company has concentrated over the years has a direct link to increasing its advertising income.
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On the advertising metrics front, Google's aggregate paid clicks has been on the rise while its aggregate cost per click is on a decline. The trend has continued for more than three years in a row so let's take a closer look at the numbers to see how this will impact Google's future advertising revenue.
As you can see from the chart above, between third-quarter 2013 and third-quarter 2015, Google's cost per click declined for all quarters while aggregate paid clicks kept expanding at double-digit rates. That trend continued until the most recent quarter, with aggregate cost per click (year over year) declining by 11% while aggregate paid clicks increased by 33%. Fortunately, the decline in cost per click was overcompensated by the growth in paid clicks, and Google's advertising revenues during the quarter expanded by 18%.
That strong growth has been ongoing for the past several years right into the first three quarters of the current fiscal. It would appear that declining cost-per-click figures has had little to no impact on the company's ability to expand its top line. The biggest reason for that is obviously the healthy growth in paid clicks.
That sort of conflicts with what we're seeing in terms of Internet usage transitioning from desktop-heavy to mobile-heavy. Even though Google and Apple (AAPL), through their Android and iOS mobile operating systems, have ensured that mobile devices get into as many hands as possible, this doesn't seem to have moved advertisers to spend more on mobile advertising. Desktop still trounces mobile when it comes to advertising dollars. That does affect Google by pulling down its cost per click, but it seems to have found a way to keep increasing paid click volume to more than offset it - and even afford it stellar growth.
What makes Google's ad revenues sustainable?
A major factor now positively impacting the longevity of Google's ad revenue growth is the slowing growth rate of the smartphone user base in developed markets. With penetration already near 70% levels in most lucrative markets, the only growth that's being seen is in the APAC region.
"The global devices market is stagnating. Mobile phone shipments are only growing in emerging Asia/Pacific markets, and the PC market is just reaching the bottom of its decline." - Ranjit Atwal , research director at Gartner (IT)
Cost per click in developed markets will always be much higher than you can get in developing markets so the growth of smartphones in APAC isn't expected to hit Google's top line in a negative manner.
An even more important metric is the growth of digital advertising spending around the world, which is the real driver of Google's continued growth in its core revenue segment.
"Digital ad spending (including mobile) will increase by 20.3% to reach $194.60 billion in 2016, making up 35.3% of total media ad spending. By 2020, spending will top $335 billion and represent over 46% of total media ad investment." - emarketer
With Google seeing paid clicks growth at much stronger levels than the decline in costs per click, its growth is all but guaranteed over the next several years. Part of that success comes from the fact that Google's AdWords is still the go-to place for online advertisers. Facebook (FB) is another key destination, but the company's recent problems with metrics reporting and the management's own warnings about ad loads reaching their peak means that the bulk of advertisers will still keep flocking to Google rather than Facebook or any other platform.
Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.
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This article first appeared on GuruFocus.
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