Alphabet Inc. Class A (NASDAQ:GOOGL): Rising Costs Overshadows Ad Revenue Growth Triggering Sell-off

Alphabet Inc. Class A (NASDAQ:GOOGL) shares tumbled despite the search giant reporting first-quarter earnings that topped Wall Street estimates. Concerns about rising costs and contracting margins is the latest headwind that appears to have triggered sell-off of the stock.

Google Q1 Results

The tech giant posted a 26% increase in Q1 revenue that came in at $31.1 billion. Operating income was up 22% coming in at $7 billion. Earnings per share surged to $9.39 a share, against consensus estimates of $9.28 a share.

Advertising business accounted for a huge chunk of the search giant revenue, on increasing 20% year-over-year to $26.64 billion. Growth in ad sales suggests privacy concerns which have become rampant in the wake of Facebook Inc. (NASDAQ:FB) scandal have not yet had any impact on the tech giant business.

Growth in advertising revenue according to the company underscores the fact that mobile search and programmatic advertising are growing. Sales from the cloud business was nearly $4.3 billion an increase from $3.2 billion reported a year earlier.

Despite the high growth in revenue, a surge in operating expenses continues to raise serious concerns among investors. Long-term capital expenditure in the quarter nearly tripled to $7.3 billion from $2.5 billion a year earlier. In its defense, the company attributed the surge to an increase in cost for acquiring streaming rights for YouTube’s new TV service and marketing of new products.

During the quarter, the company also increased expenditure on major projects such as real estate properties and computers. About $2.4 billion of capital expenditure was used to purchase the Chelsea Market building in New York.

Rising Operation Costs

Traffic acquisition costs which include money spent on phone manufacturers to run ads and services hit $6.28 billion in the quarter accounting for 24% of advertising revenues. Operating expenditure in the quarter was up 27% to $10.7 billion, attributed to an increase in research and development costs.

Increased capital expenditure saw the company operating margins shrink from 27% to 22%. First quarter operating margin was the smallest for the tech titan since 2012.

Even with the drop, Google announced that the upward spending trajectory is set to continue.

“The opportunity set ahead of us is quite extraordinary, and we remain focused on investment to support long-term revenue and profit growth. We have both the business confidence to invest appropriately in the next phase of innovation as well as clarity about some very compelling opportunities,” said Ruth Porat Google Chief Financial Officer.

Google appears to have bought a leaf out of Amazon.com, Inc. (NASDAQ:AMZN) playbook when it comes to capital expenditure in pursuit of long-term growth opportunities. Google executives insist that spending is necessary if the company is to install powerful computers and internet cables to keep up with the growing YouTube demand and data analytics tools within the Google cloud services.

Google is also ramping up investments on non-advertising related investments given that digital marketing has come under pressure over privacy concerns in recent months

While Google shares have risen by more than 20% over the past one year, increasing selling pressure threatens to erode a good chunk of the gains