Taking a break from the recent Dow Theory series to give my two cents on today’s earnings beat by Google. It’s a stock I own so I’m understandably thrilled by Google’s recent earnings report. Google’s shares had shed nearly 40% of their value since reaching a peak at $750 and fallen to their 52-week low before jumping 20% on today’s report. So, what can we learn from this report?
Analysts don’t have a clue
The slew of negative revisions in earnings expectations and hand waving on Google’s revenue and earnings potential over the last quarter seems to have all been in vain as the company didn’t miss a beat despite working on an initiative to decrease clicks with hopes of improving the quality of leads generated by their ads. It turns out that online advertising budgets continued to grow, click growth was not nearly as low as some believed, and Google has very quickly monetized their improved click quality.
It’s not completely the fault of big-time analysts that they got Google so wrong. Unfortunately, Google does not offer forecasts on its business. This may be due to the fact that the online space is very difficult to understand and project. As with anything that is poorly understood and potentially volatile, the market punished Google with severe multiple compression as the general economic outlook turned murky in the last few months. I think, now, we see that this was undue punishment and that Google’s franchise may be even stronger than some believed.
Online advertising is far from mature
A significant worry of many Google bears was that consumer searches for commercial products online would decline as consumer spending cut back during a possible recession. Instead, we find that CEO Eric Schmidt’s belief that quantifiable advertising would be seen as a safe haven for shrinking ad budgets was closer to the truth. Despite potentially slackening ad budgets, search and online advertising seems to have drawn a larger share of advertising interests as companies look to maximize their ad spend. Furthermore, shrinking consumer spending seems to have worked in Google’s advantage as there is some belief now that more consumers are going online to do more research and price comparison before shopping.
What we see here is that even though Google looks like a behemoth in online advertising, the online advertising market is still far from mature and is still in the process of taking market share in the much larger advertising industry. The impressive fact is that despite shrinking ad budgets and falling consumer spending, Google still managed 20% paid click growth (throughout its network) and 30% earnings growth. Not to be overly bullish, but this bodes very well should Google retain its market share through this downturn and ad spending picks up once again. Google’s position as the leader in online advertising positions it to benefit most in the shift from traditional marketing routes to internet distribution.
Global growth is still a play
IBM’s earning report earlier this week was a good indicator that US companies positioned well overseas were well-positioned to weather any economic downturn in the US. Google, too, is a far more international company than many people realize. While it does not have a dominant presence in some overseas markets, namely Japan and China, it did receive 47% of its revenue from overseas channels last quarter. That number grew this quarter to 51%.
Google continues to have big plans for its operations overseas particularly in the mobile markets that are exploding throughout Asia. The innovations it makes to capitalize on mobile internet will only continue to provide a driver for growth both abroad and here at home. Google recently doubled market share in China from 13% to 26% though it still trails rival Baidu which owns, a nearly-Google-like, 60% of the Chinese search market and has longterm plans to take the top spot within 5-years. It is also surprisingly trailing Yahoo in the Japanese market (66% to 29%) though Google has recently signed a groundbreaking deal with Japan’s largest mobile provider, NTT Docomo, that gives Google the early edge in the mobile internet market.
One potential negative
Comscore defended its paid click numbers today and could lead to some questions about where online advertising may plateau. Comscore believes that Google’s paid click numbers are materially different from theirs because they only track paid clicks on Google’s US search service while Google presents an aggregate number including AdSense (used on this site and many others), services, and internationally. If Comscore’s numbers are correct, this could be a signal that Google’s search advertising may be as saturated as it will get with growth only coming through increasing prices. This would make sense given that Google search commands nearly 70% of the US search market. Though, with Yahoo! potentially throwing in the towel and continued changes in how internet users accept internet advertising, who knows? (Back to the difficulty in predicting and understanding a company like Google.)
Lessons for me as a trader/investor
I’m an idiot. In my Curious Investments Q1 Review, I went over a little chart analysis which showed very clear signals for selling Google’s stock near $690-$700. No, this wouldn’t have been the top of $750, but it would have been a very strong and very quick gain on my investment. When I made the investment in September, I had a target price in the mid-$600s based on 2008 projections and a forward P/E of 30, justified by the very crude assumption that PEG ratios tend towards 1. In November, my analysis showed that upside valuation on the 2-year horizon might be around $710. As a rational and conservative investor, I should have shed my Google stocks when these targets were reached or if I was truly diligent about my chart reading skills when Google’s charts indicated two lower highs after hitting $750, but I let greed and market enthusiasm cloud my judgment. Never again…
For those who were smarter than me, a play on Google with a proper and conservative sale in the high-$600s when full valuation was reached followed by a purchase as shares bottomed near $450 this past month, could have proven significantly lucrative. Given the negative news surrounding Google why would a purchase at $450 make sense? Well, one could assume that a price of $450 factored in a huge earnings miss (earnings of 10-15% vs. true earnings of 30%) given the compression in P/E below 30 and forward P/E in the low-20s/high-teens. Furthermore, a person who understood Google’s position as a firm that is not in a mature industry, taking market share, and internationally diversified, could be relatively confident in at least stable earnings and the potential for continued performance to bring Google’s valuation back to its old September basing levels – ~$550 – would have represented margin of safety in excess of 20%.
If you read the posts I mentioned above, you will realize that this not simply hindsight proving 20/20, but a very realistic scenario for a truly adept investor who understands market technicals. The only requirement is freedom from greed (to be able to sell) and an ability to remain confident in your understanding of a company (to be able to buy again). Hopefully, the lessons I’ve learned from this trade/investment in Google will serve better in the future. For now, until the economy improves, I have my price target on Google set to $635 by the end of the year. Should the stock rebound more swiftly than that, I will be ready to sell to realize profits as I should have in January.