Alphabet had more than $70 billion in market cap wiped out, and it says YouTube is one of the problems

Key Points
  • Alphabet reported a sharp decline in ad revenue growth Monday, sending the stock down more than 8% on Tuesday.
  • Alphabet's CFO said changes to the YouTube algorithm caused lower engagement and ad revenue growth on the site.
  • Ruth Porat was probably referring to changes YouTube made to curb the spread of fake news and conspiracy theories. It shows YouTube is willing to forego some short-term ad revenue for the long-term health of the company.
Alphabet beat on earnings, but reported a Q1 revenue miss—Here's what five experts are watching now
Alphabet beat on earnings, but reported a Q1 revenue miss—What 5 experts are watching

Google has a YouTube problem, according to CFO Ruth Porat.

On Monday, after reporting that ad revenue grew 15% versus the 24% it saw a year ago, Google's parent company Alphabet saw its stock punished. It fell more than 8% Tuesday afternoon.

According to Porat, YouTube was one of the culprits.

"While YouTube clicks continue to grow at a substantial pace in the first quarter, the rate of YouTube click growth rate decelerated versus a strong Q1 last year, reflecting changes that we made in early 2018, which we believe are overall additive to the user and advertiser experience," Porat said on the company's earnings call Monday.

Porat didn't expand on precisely what changes at YouTube led to the poor ad revenue growth, and Google isn't saying anything beyond her statements from Monday.

But if you wind the clock back a year, it's easy to see what happened.

In the first quarter of 2018, Google began making changes to YouTube's algorithms designed to stop harmful content from appearing in the feed of recommended videos you see on the side of a video page.

The goal was to make it harder to find videos full of conspiracy theories, fake news and all that other detritus that occasionally sent advertisers fleeing from the platform. Instead of YouTube directing you to a conspiracy theory about the latest school shooting, you were shown related videos from "authoritative" news sources the company considered worthy of bringing you accurate information.

On top of that, YouTube has removed millions of channels and videos that violated the company's harmful content policies, most notably Alex Jones.

But all of those garbage videos also kept engagement high. It kept YouTube users tuned in to their feeds beyond the video they came to watch, even if the company said they only made up less than 1% of all videos on the site.

YouTube was literally incentivized to keep its algorithms pumping junk to the top of people's feeds so people would keep watching and the ad dollars would keep flowing. A devastating Bloomberg report earlier this month showed that for years YouTube executives ignored warnings from their own employees that the misinformation and nastiness on the site had gotten out of hand.

For a long time, they chose the money over managing the mayhem.

Today, YouTube says it's serious about cleaning up the issues that have plagued the site for years. But that cleanup appears to have come at the short-term cost of ad revenue growth. (Although it's possible that Porat was referring to other types of changes, or engaging in some selective disclosure to guide investors away from other reasons for the growth slowdown.)

Investors punished the company on Monday by vaporizing more than $70 billion from its market cap.

But if YouTube can fix its content problems and continue to grow beyond its nearly 2 billion users, it has a chance to benefit in the long term.

The new system is still far from perfect, as The New York Times' Kevin Roose pointed out in an interview with YouTube's chief product officer, Neal Mohan. It's still possible to fall down a rabbit hole of horrible videos on YouTube. But, based on Porat's comments, the changes were effective enough to hurt YouTube engagement.

In a statement to CNBC, a Google spokesperson downplayed the amount of revenue generated by bad content on YouTube. The statement did not address the impact removing that content had on revenue growth.

"There's a misconception that YouTube makes money off of recommending 'radical' content, but the truth is that very little of this content makes any kind of meaningful money. In fact, when we cleaned up our partner program to remove bad actors last year, we made it clear that 99% of those impacted creators were making less than $100 a year," the statement said.

Still, analysts on Tuesday didn't sound too worried about YouTube's longer-term prospects, and cautioned there are other factors playing into the ad growth deceleration.

"YouTube has increased its focus on responsibility and safety, and it adjusted its algorithm in 1Q to reduce recommendations of content that comes close to violating guidelines or is misinformed or harmful," J.P. Morgan analysts wrote in a research note Tuesday morning. They added that, "we don't think there's a single clear answer for Google's [deceleration], but a number of factors are at work."

With billions in market cap gone and analysts already downgrading Alphabet's stock, the biggest question surrounding YouTube today is whether it will continue making improvements to curb the spread of toxic content or be shocked back into inaction for the benefit of its shareholders.

Correction: An earlier version of this story linked to the wrong YouTube blog post announcing changes to content moderation.

Alphabet loses $80 billion in market cap after revenue miss
Alphabet loses $80 billion in market cap after revenue miss