If all you did was look through a collection of headlines last week, you would think Google was in crisis.
Not only did its financial printer embarrass the Mountain View, Calif., giant by accidentally publishing its results for the third quarter early, but the numbers were deemed to have missed expectations and the stock tanked.
It’s a classic case of the short-term thinking that Wall Street specializes in.
To understand why the headlines were so negative, we only need to look at the numbers Wall Street cares about most: Google’s core revenue and its overall earnings per share.
Core revenue was $11.3-billion (U.S.) versus expectations of $11.9-billion. And earnings per share were only $9.03 versus expectations of $10.65. Ouch.
But let’s look beneath those highly publicized figures. Being a long-term investor, I don’t care if the stock drops for a little while. I care about how the business is performing.
My conclusion? If you strip out the effects of currency fluctuations and acquisitions, Google is actually doing quite well.
The search giant is in the process of digesting its largest-ever acquisition (it acquired Motorola Mobility for over $12-billion in May 2012). A deal that big is going to throw a monkey wrench into Google’s cost structure for a little while, so it’s not that surprising if earnings dip.
What patient investors should focus on is whether revenue is still growing and if there are any developing cracks in the business model that could affect long-term profitability.
Google’s Canadian-born CFO, Patrick Pichette, provided some good insight into these issues on the conference call that followed the earnings report. He said that revenue at the core Google (excluding Motorola) grew 19 per cent year over year. This would have been 24 per cent in the absence of currency fluctuations.
That’s a healthy level of revenue growth by any measure – but one that seems to have escaped most of the press coverage. I’ve seen several headlines saying that Google’s revenue is dropping. The writers mean to say that the rate of growth is slowing. But that’s not what they write and people get misled.
Google is an advertising company. It generates revenue when web surfers click on ads. The volume of paid clicks was up 33 per cent year over year.
To be sure, there were problems. Revenue growth of 24 per cent lagged volume growth because advertisers are paying less for clicks. Many analysts were quick to say that was a sign of weakness.
My response? First, if 24 per cent growth is “weakness,” I’ll take it. Second, let’s look at the reason for the falling cost of clicks. It’s mostly because a higher proportion of clicks are coming from mobile devices. These are less lucrative than clicks on desktop computers, but investors should keep in mind that the industry’s ability to turn traffic on mobile devices into cash is still in its infancy.
“We are seeing tremendous innovation in advertising, which I believe will help us monetize mobile queries more effectively than desktop today,” Larry Page, Google’s CEO, said.
Wall Street doesn’t trust his optimism. I’m different because I’ve been a Google advertiser for several years and I’ve seen the innovations Google has introduced over this period, such as the ability to overlay ads on YouTube videos. I’m not willing to bet against Mr. Page and his team.
I’m a long-term investor so I’m looking at the latest results as a chance to sanity-check my thesis.
Here’s one thing that makes me feel rather confident: Did you know that Google has more than tripled its year-over-year revenue coming from mobile devices? In the third quarter of last year, those revenues were running at an annualized pace of $2.5-billion. A year later it’s $8-billion. To be fair, Google is including revenue from the Google Play store (apps and content) in this year’s number, but the vast majority of the $8-billion comes from ads.
So while Wall Street is busy having a panic attack regarding missed estimates and falling cost per clicks on ads, they’re missing the big picture. Mobile is growing like a weed, and there is nothing to suggest that the overall business model in terms of profit margins is any worse in mobile.
I expect this to be reflected in earnings per share over the next few quarters. I’ll watch for signs that this happens. If it doesn’t, I’ll re-examine my case for holding Google.
Until then, I’ll happily continue to own Google shares, both personally and in my Strategy Lab model portfolio.
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