Friday, July 18, 2008

Panicky Investors: "OMG! Google is teh DOOMED!"

Wow, so Google was only able to increase profits by 35% and revenue by 39% in an extremely challenging economic environment. Seriously, most companies would kill for this type of growth during the best of times and Google is producing it during a slowdown and in a seasonally weak period for search. The 3.2 billion dollar purchase of DoubleClick (which significantly lowered their cash position) and the decline in interest rates also reduced the return on their cash position.

It is also not like they are sitting around doing nothing about it, they are watching their budget more closely, are holding expenses down relative to revenue and have slowed their rate of hiring. I see the slowdown in hiring as a positive, but for some reason, many in the financial press are bemoaning this as a negative. One of the major challenges that companies like Google and Apple have face in hiring is finding enough qualified people. I would be more alarmed if they ignored the economic realities and continued hiring and spending at their previous rate. I see Google as the type of company where having too many employees will run up expenses without significantly increasing profits. I believe that Google is currently well staffed for its current initiatives and does not need to significantly increase headcount to achieve its goals. In tech R&D quality is a lot more important than quantity both in terms of dollars and staff. Look at Apple vs. Microsoft as a good example. Microsoft outspends and outstaffs Apple several times over, but Apple continually produces better and more innovative products. Controlling spending and cutting waste is always a good thing in my book, and a slowdown can be just the thing to force a prioritization in spending which will increase efficiency and ensure the future good health of a company.

The other important point to consider is that Google is maturing and already controls a huge portion of the market, they handle 69% of all search queries and bring in over 77% of all search advertising revenue. They simply will not be able to continue their previous levels of growth forever. While they are rapidly moving into new territory and I trust Google to innovate and find new opportunities better than 99% of the companies out there, it is simply impossible to grow profits which are over a billion dollars per quarter as fast as when they were in the millions.

I would recommend keeping a close watch on this stock this quarter. If it pulls back significantly due to panic selling related to this earnings disappointment, it could represent an excellent buying opportunity. Google is the undisputed leader in search and one of the most innovative companies around. I am routinely amazed by the products they release which are often exponentially better than those of their competitors (even if they remain in beta forever :).

Full Disclosure: I have been long GOOG continuously since August 19th, 2004
Google 2Q letdown raises economic worries (Excerpts from AP Story featured on Yahoo!)
SAN FRANCISCO (AP) -- Google Inc.'s earnings growth bogged down more than investors anticipated during the second quarter, raising worries that the ailing U.S. economy is starting to sap the Internet search leader.

Google earned $1.25 billion, or $3.92 per share, during the three months ended in June. That represented a 35 percent increase from net income of $925 million, or $2.93 per share, at the same time last year.

If not for costs incurred for employee stock compensation, Google said it would have earned $4.63 per share. That figure missed the average earnings estimate of $4.74 per share among analysts surveyed by Thomson Financial.

It marked just the fourth time that Google hasn't exceeded analyst expectations in its 16 quarters as a public company.

Investors expressed their dismay as Google shares plummeted $40.70, or 7.6 percent, in Thursday's extended trading after closing at $533.44, down $2.16.

Google's second-quarter revenue fared slightly better than earnings, rising 39 percent to $5.37 billion from $3.87 billion at the same time last year.

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