Known for wanting to be everything to everyone, Google often seems misunderstood in the eyes of investors. Whether in smartphones or tablets, apps or maps, and now Google is working to become an ISP, an internet service provider.
While you would be correct to call this variety of ambitions scattered, you must also call Google successful. And the company’s stock price, which recently hit a wall after reaching $928, has become a concern for investors, who are worried about the company’s growth potential.
Despite its search dominance, Google never rests.
The company is in simultaneous battles with titans like Apple and Facebook to win control over mobile and social media, while at the same time fighting a war with Microsoft in device browsers and operating systems. As if this was not enough, now Google wants to take on other ISPs like Time Warner Cable.
Essentially, Google couldn’t find a dull moment no matter how hard it looked. What it also means, though, is that the company must spend a lot of money to fund these wars.
And for a big as Google is, the fact that the company is still able to grow at a 20 per cent rate is no small accomplishment. This level of growth does not come cheap. And it’s time that investors come to terms with what they are paying for when buying these shares.
Upon reaching its new 52-week high of $928, the stock lost roughly 6 per cent, falling as low as $875.61 following its second-quarter earnings report, in what I can only describe as an overreaction.
I will grant that the 65 per cent decline in Motorola’s revenue was a pretty significant number, but let’s not pretend that it’s been a key component in Google’s growth. It’s a legacy business that’s being phased out of Google’s core operation.
Despite Motorola’s poor showing, which should not be confused with a disappointment, Google still posted 19 per cent growth in consolidated revenue. When factoring the 16 per cent growth in web site revenue and the slight decline in network revenue, the company still managed to grow overall net revenue by 21 per cent. Net revenue is realized when all the extras outside Google’s core business are taken out.
Yet, the Street chose to focus on Google’s declining margins. In previous earnings reports, consolidated revenue had been significantly higher than net revenue. In this instance, the role has been reversed.
I think investors have missed how important this is. You’ll get no argument from me that the six-point decline in gross margin was unsettling. But what else do you expect?
As I’ve detailed above, Google is not operating like a mature company that is content with living off its historical accomplishments. Google is operating as a startup and is spending tons of cash by taking on several new projects.
Besides, let’s not pretend that this quarter was a complete disaster.
Google bears who can’t stomach the $900 stock price insist on pounding the obvious – labouring on the 4 per cent decline in operating margin. Yet, despite the weak margins, the company still managed to grow non-GAAP operating income by roughly 3 per cent. What this means is that management was able to figure out ways to squeeze every available penny out of every dollar it generated in revenue.
What’s more, there will be a time when the Motorola business is no longer impeding the company’s momentum. At that point Google might have already shifted direction into another venture. That is to be expected.
In other words, volatility and profit swings should also be expected. I love solid margins just as much as the next analyst, but in Google’s case, we need some perspective.
I’m not suggesting that Google is flawless. But there’s no denying that the company operates a sound business, even amid rising operating expenses – as scary as they are.
This goes back, though, to the question I asked earlier: Investors have to know what they’re paying for. If you want the strong growth that Google has consistently provided, you’re going to have to sacrifice some nights of restful sleep.
I have always liked Google’s stock and I don’t believe that this story has changed. I’ve always said that the best way to evaluate Google’s stock price is on a five-year basis. And projecting five years out, I still see mid-to-high double-digit revenue growth, which means this is far from a mature company.
With the stock having reached $928 recently, predicting $1,000 a share wouldn’t be sticking my neck out too far. But with rising free-cash flow and management’s ability to realize value from the company’s recent investments, I can see the stock reaching $1,200 by this time next year, if not sooner.