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The High Cost Of Being Google
The senior leadership of public companies have two primary responsibilities. The first is obvious: to run the business as best they can for the benefit of shareholders, employees and other stakeholders. The second obligation is not often discussed openly: to manage the company's relationship with the Street. I do not believe there is any question that Google (Nasdaq:GOOG) succeeds on the first metric, but this second quarter puts the second metric into question.
Fortunately for shareholders, though, running the business is vastly more important in the long run. Companies may court unwanted volatility and undervaluation by not sufficiently managing the Street, but it is ultimately the stone cold fundamentals that matter and Google has little to fear there.
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The Quarter That Was
Google posted 24% top-line growth for the second quarter, and 25% growth in net revenue (after excluding traffic acquisition costs). Paid clicks, arguably the most-followed revenue metric, were up 15%. The company saw solid overall revenue growth in theU.S. (26%)
Unfortunately, that is likely to be seen as the last of the good news by some people.
Expenses were up in the quarter, as the company spent heavily on R&D and employee additions. This led to a slight drop in operating margins sequentially, although the company's EBITDA was up 20% on an annual basis. (To learn more about what this means, see A Clear Look At EBITDA.)
When I look at this report, I have no problem with the company's decision to spend as they did. It is this heavy ongoing R&D spend that allows for new ventures like the Android operating system, which may provide the next leg of growth in the story. The problem, though, is that the company does not always explain itself as well as it could. Management was somewhat evasive on its call and clearly did not get the message out to analysts ahead of time about their spending intentions for the quarter.
Longer Term, Who Cares?
If you are like me, however, and focus on the marathon instead of the sprint, none of this is problematic. Google dominates the paid search market, and there are no real signs of life from Yahoo! (Nasdaq:YHOO) or Microsoft (Nasdaq:MSFT) that concern me. Moreover, Android looks like a solid threat to Apple's (Nasdaq:AAPL) platform, and the release of the new Droid X by Motorola (NYSE:MOT) and Verizon (NYSE:VZ) should feed the already-solid momentum in that business.
Even though I think Google will have a tough time maintaining its margins over the long term, I think the company will continue to translate R&D spending into new revenue drivers.
The Bottom Line
Google's founders have claimed in the past to run the company according to the philosophy of "don't be evil", but re-introduction of Pac-Man and the torching of 4.8 million hours of productivity is a bit suspect. However, I am willing to let this slide, especially if they bring out Donkey Kong next.
On a fundamental basis, even a value guy like me can find plenty to like in Google's stock. Unless you really see Google's cash flow yield just falling off a cliff, it does not take more than high single-digit growth assumptions to give you an investable margin of safety with this stock. Although I do not like to invest in closely-scrutinized bellwethers like Google (there is just too much hassle with "expectations"), investors looking for a solid tech idea should certainly at least give some thought to Google shares.
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Fortunately for shareholders, though, running the business is vastly more important in the long run. Companies may court unwanted volatility and undervaluation by not sufficiently managing the Street, but it is ultimately the stone cold fundamentals that matter and Google has little to fear there.
IN PICTURES: How To Make Your First $1 Million
The Quarter That Was
Google posted 24% top-line growth for the second quarter, and 25% growth in net revenue (after excluding traffic acquisition costs). Paid clicks, arguably the most-followed revenue metric, were up 15%. The company saw solid overall revenue growth in the
Unfortunately, that is likely to be seen as the last of the good news by some people.
Expenses were up in the quarter, as the company spent heavily on R&D and employee additions. This led to a slight drop in operating margins sequentially, although the company's EBITDA was up 20% on an annual basis. (To learn more about what this means, see A Clear Look At EBITDA.)
When I look at this report, I have no problem with the company's decision to spend as they did. It is this heavy ongoing R&D spend that allows for new ventures like the Android operating system, which may provide the next leg of growth in the story. The problem, though, is that the company does not always explain itself as well as it could. Management was somewhat evasive on its call and clearly did not get the message out to analysts ahead of time about their spending intentions for the quarter.
Longer Term, Who Cares?
If you are like me, however, and focus on the marathon instead of the sprint, none of this is problematic. Google dominates the paid search market, and there are no real signs of life from Yahoo! (Nasdaq:YHOO) or Microsoft (Nasdaq:MSFT) that concern me. Moreover, Android looks like a solid threat to Apple's (Nasdaq:AAPL) platform, and the release of the new Droid X by Motorola (NYSE:MOT) and Verizon (NYSE:VZ) should feed the already-solid momentum in that business.
Even though I think Google will have a tough time maintaining its margins over the long term, I think the company will continue to translate R&D spending into new revenue drivers.
The Bottom Line
Google's founders have claimed in the past to run the company according to the philosophy of "don't be evil", but re-introduction of Pac-Man and the torching of 4.8 million hours of productivity is a bit suspect. However, I am willing to let this slide, especially if they bring out Donkey Kong next.
On a fundamental basis, even a value guy like me can find plenty to like in Google's stock. Unless you really see Google's cash flow yield just falling off a cliff, it does not take more than high single-digit growth assumptions to give you an investable margin of safety with this stock. Although I do not like to invest in closely-scrutinized bellwethers like Google (there is just too much hassle with "expectations"), investors looking for a solid tech idea should certainly at least give some thought to Google shares.
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Stephen D. Simpson, CFA
Stephen D. Simpson, CFA, is a freelance financial writer, investor, and consultant. He has worked as an equity analyst for both sell-side and buy-side investment companies in both equities and fixed income. Stephen's consulting work has focused primarily upon the healthcare sector, while he has also written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson operates the Kratisto Investing blog, and can be reached there.
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