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Three letters — TAC — could drive Wall Street crazy when Alphabet reports after the bell

  • Alphabet reports earnings after the bell on Thursday.
  • It's expected to report adjusted earnings of $8.33 per Class A share on revenue of $27.2 billion, according to a consensus estimate from Thomson Reuters.
  • That would be about a 21 percent surge in revenue compared with a year ago — but about an 8 percent drop in profits per share.

Wall Street is expecting Alphabet — Google's parent company — to extend its sales growth for yet another quarter as it continues to dominate the search advertising market.

But rising costs could squeeze profits as the company transitions from its "bread and butter" search business toward artificial intelligence and other ventures, analysts predict.

A woman takes pictures of a sign after the opening of Google's pop-up store in New York.
Jewel Samad | AFP | Getty Images
A woman takes pictures of a sign after the opening of Google's pop-up store in New York.

Alphabet reports earnings after the bell on Thursday, when it's expected to report adjusted earnings of $8.33 per Class A share on revenue of $27.2 billion, according to a consensus estimate from Thomson Reuters.

That would be about a 21 percent surge in revenue compared with a year ago — but about an 8 percent drop in profits per share. This time last year, Alphabet reported revenue of $22.45 billion and adjusted earnings of $9.06 a share.

Part of the reason? Traffic acquisition costs (TAC), or the amount Google pays to drive clicks to its ads. This time last year, Alphabet reported total TAC of $4.18 billion — this quarter, analysts expect that to balloon to $5.24 billion, according to StreetAccount.

Ruth Porat, Alphabet's chief financial officer, said last year that investors should expect pressure on profit margins, since search ads on mobile and programmatic-style ads bring in more revenue, but at a lower margin.

Ruth Porat, CFO of Alphabet, at the New York Economic Club on May 22, 2017.
Adam Jeffery | CNBC
Ruth Porat, CFO of Alphabet, at the New York Economic Club on May 22, 2017.

For instance, Apple said this quarter that Google would become the default web search option for Siri on iOS, and these types of deals have cost Google billions in the past, according to estimates.

"TAC trends will be a focus this quarter, as mobile advertising impression success remains a key going forward for Google in this very competitive land grab market opportunity," wrote Daniel Ives, head of technology research at GBH Insights, in a research note.

Alphabet's wide reach — from Waymo's self-driving cars to its cloud business to leading an investment round in Lyft — means that the company has plenty of options to make money outside of search.

Alphabet's Google business also contains Google Shopping, Maps, YouTube, Android, Chrome, Google Play and the burgeoning hardware division. Google launched its Pixel 2 phone this fall and has expanded options for Google Home and Google earbuds.

Then there are the "other bets," including Google's start-up investing arms, Verily life sciences research and Nest smart-home devices.

Unfortunately, it's hard for Wall Street to get excited about some of these businesses — Google hasn't revealed YouTube's revenue, a frustrating part of forecasting earnings, wrote Benjamin Schachter, of Macquarie Capital. And the "other bets" are only expected to make $263.4 million during the quarter, according to StreetAccount's estimate, even as Porat has tried to push for more payoff. Amazon's Alexa and a nascent advertising business are also in Google's peripheral.

"[T]he evolving businesses in Cloud, Google Play, hardware, and 'Other Bets' all remain interesting opportunities, but again, based on the track record, we don't see these being meaningful ... in the foreseeable future," Schachter wrote. "We continue to believe that the Cloud business has the biggest potential, but think it is likely going to need a significant acquisition in order for it to become more relevant to the financial model and investors."

Google also faces regulatory pressure on its core business, expected to come to a head next week as tech companies testify on Capitol Hill about the role of Russian political advertising in the 2016 election. Meanwhile, in Europe, Google's Shopping division may have to shift focus to deal with a record-breaking antitrust fine.

Nonetheless, Alphabet should have plenty of money to deal with any missteps. Google will control about 58.8 percent of the search ad market worldwide this year, eMarketer projects.