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Breaking down 2 quarters of misses with Alphabet investors

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Breaking down 2 quarters of misses with Alphabet investors

Investors are not pleased with lately.

Shares are down 8.9% year to date in 2016, deeper than aloss of 5.6% for the SNL Kagan New Media Index. Yet during the 12 months endedMay 3, the company grew its market capitalization by 28.5%, outpacing a declineof 1% for the new media index.

Looking back, investors responded warmly to earnings reportsfor the second and third quarters of 2015 but poorly to the financials releasedsince, which included more detailed disclosures following the company'srestructuring.

The first upswing came after July 16, 2015, when Alphabet(then Google Inc.) reportedaccelerated profits and a jump in YouTube usage in its second quarter of 2015.The stock enjoyed a one-day gain of 16.8% after the release, which representeda new high value for the company.

That new valuation for the search giant kept bulls in checkuntil the Aug. 10, 2015, announcement that Google would form a , AlphabetInc., with the advertising business retaining the Google name and becoming asubsidiary of Alphabet. Following the change, the company broke out disclosuresfor Google's advertising business, which includes YouTube, and its "OtherBets" segment, which includes forward looking investments in areas likelife sciences, state-of-the-art broadband delivery, driverless cars and other "moonshot"projects. Investors applauded the plan, sending the stock on another upwardclimb that continued after the company's first reporting period as Alphabet.

But then the market turned sour on Google in the face ofbelow-consensus earnings results in the last two quarters that were drivenpartly by currency headwinds.

Shares lost some steam in February after the companyreleased its fourth-quarter2015 results, the first that offered the new segmented results under theAlphabet parent. Revenue was up 18%, but the FX headwind was real. On aconstant-currency basis, revenues would have gained 24%. Alphabet executivesalso said that growing programmatic and mobile advertising helped drive therevenue figure, which would hurt Google on the expense line. Despitean after-hours pop in Alphabet shares following the fourth-quarter release, thestock dropped over 8.5% in the following trading week.

Alphabet had a similar experience with its report.Advertising revenue gained 16.2% to $18.02 billion, leading to a 17.4% jump incompanywide revenue, at $20.26 billion. Net income also grew significantly,with EPS climbing over a dollar to $7.50.

However, analysts and investors wanted more. The S&PCapital IQ consensus estimates going into the report called for $20.36 billionin revenue and EPS of $7.96.

Again, currency and expenses proved to be the company'sAchilles Heel. On a constant-currency basis, Alphabet revenues grew 23%.Traffic acquisition costs were up 13%. Cost of revenue grew to 37.8% of totalrevenues, up from 36.8% in the prior-year period. Operating expenses grew byover $2 billion. Traffic acquisition costs jumped 13% to $3.79 billion from$3.35 billion a year prior.

Again the company's executives pointed to strong growth inprogrammatic and mobile advertising as drivers of revenue growth, but theyadded additional commentary: The programmatic and mobile businesses came withincreased traffic acquisition costs.

Not long ago, one of the complaints against Google was itslack of mobile penetration, and the company has made that a particular area offocus and investment in recent months. Google CEO Sundar Pichai said during thefirst quarter report that mobile search on Google Chrome recently surpassed 1billion monthly active users. But the news came at a cost, in expenses thatweighed on the bottom line. Shares dropped over 9% after the report and throughthe following trading week.

The miss on revenue was driven by another dynamic: foreignexchange.

Several companies have been reporting big discrepanciesbetween actual revenue results and currency-adjusted revenues, and Alphabet hasbeen hit particularly hard by the strong U.S. dollar. Looking at the exchangerate between the U.S. dollar and the Swiss Franc, considered one of the moststable currencies in the developed world, the fourth quarter saw a notablesurge in this metric. The rate climbed almost 10% from April 2013 during thisperiod. It began to moderate in the beginning of 2016, but stayed elevatedenough to sour Alphabet's earnings.

Since its Alphabet conversion, investors have been generallybullish on Google. The company shows a strong "buy" recommendation onaverage among analysts, according to S&P Global Market Intelligenceconsensus. But as TheNew York Times pointed out after the first-quarter release, "Sharesof Google were priced for perfection, and the first quarter was a little lessthan perfect."

As one analyst told TheTimes, "There's nothing wrong with this company … They spent a bitmore and took in a bit less than we thought, so Mr. Market is having a moodswing. But it was a fine quarter."