Analysts eye future of red-hot digital ad market as Alphabet set to report

As Alphabet Inc. prepares to report fourth-quarter 2021 earnings on Feb. 1, Wall Street is searching for clarity on how long pandemic-era trends will continue to push accelerated growth in its core advertising business.

Google LLC advertising revenues grew by 43.2% year over year in the third quarter of 2021, representing a fourth consecutive period of double-digit gains. The unit's $53.13 billion in advertising revenue accounted for about 82% of Alphabet's total revenue during the period.

Google's mix of online services and ad-based search and video product offerings puts the company in an ideal situation to withstand various economic uncertainties heading into 2022, said Gene Munster, managing partner at Loup Ventures.

"They benefit from inflation. They benefit from consumers' willingness to spend money. They benefit from consumers that don't want to spend money when they want to sit and watch content for cheap," Munster said in an interview.

For example, if the dollar weakens, advertisers end up spending more to ensure continued engagement with their brands' messaging.

Angelo Zino, senior analyst at CFRA Research, is expecting another quarter of significant growth from video-sharing platform YouTube LLC. Still, Zino is expecting some level of slowdown in the ad business, which is already showing signs of leveling off.

"You're going to see the business slow down in terms of the top line ... that's just to be expected in one of the tougher comps," Zino said. "You get bigger and some of the growth is just going to decelerate."

AB Bernstein internet analyst Mark Shmulik said he will be looking for detail on the performance of YouTube Shorts, an offering introduced last year to compete with popular short-form video platform TikTok.

"TikTok I think would be most of a threat to YouTube trajectory," Shmulik said. "I imagine if there's any slowdown or deceleration in YouTube revenues, you'll probably get a lot of TikTok questions centered around that."

Analysts will be looking for commentary on Alphabet's outlook as some pandemic-era trends begin to wane.

"What I don't think investors fully understand yet is, what is the new normal? What's the right steady-state margin profile?" said Bernstein's Shmulik.

Analysts said the company's cloud business could help to offset some slowdown in advertising. The cloud market is growing rapidly as more companies accelerate digital transformation plans. Still, cloud makes up a much smaller percentage of Alphabet's overall business than advertising. Google Cloud reported $4.99 billion in revenue in the third quarter of 2021, up 45% year over year.

Overall revenue may decelerate, though the company can innovate to better optimize returns from cloud adds or YouTube traffic, Bank of America analysts Justin Post and Joanna Zhao said in a Jan. 27 note.

"There is risk that Alphabet management could take a cautious approach to early 2022 outlook, signaling revenue deceleration in 1H'22 and added investment impact on margins," Post and Zhao wrote.