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Google Reports Earnings, Questions Loom

stock chartIn ancient mythology, Icarus built wings of wax to fly.  As he soared, getting closer and closer to the sun, his wings began to melt.  Eventually, in most things, what goes up eventually comes down.  It’s gravity, laws of nature.   In business the same rules can apply too.  The higher expectations get, the more likely the odds of trouble.  The bigger you get, the harder it is to fly (e.g. grow at an outrageous rate).

After the close of markets today, Google reported its earnings for the second quarter. The numbers were good, 28% growth in revenue, but expectations were high up in the atmosphere. Analysts expected lower costs, and Google failed to meet profit expectations.  It was only the second miss since Google went public in 2004.  (Google does not give sales or earnings guidance and is tight lipped about expenses.   Without sharing such information, it’s especially difficult for analysts to make accurate projections. Given the history of growth, it was only a matter of time before analyst expectations exceeded reality).

For the quarter, the numbers were still good, even if short of expected results.  Google reported sales of $3.87 billion, up 58%  over the same period last year. Excluding Traffic Acquisition Costs (TAC), which is shared advertising revenue partners, sales were $2.72 billion, beating expectations of  $2.68 billion.

Net profit was $925 million, or $2.93 per share, up 28% over last year.  Pro forma earnings were $3.56 per share, that was well short of analysts’ forecasts of $3.59 per share.

Google has spent aggressively to acquire new technologies and increase its audience draw with attractive features (from YouTube to Grand Central etc).  Research and development expenses were up almost 90 percent on the quarter.  Sales and marketing costs rose more than 80%.  That spending, which has not yet paid off in revenue, was a significant contributor to missing analyst targets. 

Sooner than later, the money they are spending to diversify and expand their advertising business will have to start paying off but investors may give a few quarters of leeway given the strength in revenue growth they continue to show.  

The missed expectations may make other investors hesitant, and will likely bring out a few of the bears to criticize the company’s performance.  So far, the majority of Google’s revenues still come from text based advertising which leads some to see them as a “one trick pony.”  For all their services, and their strength in search, their revenue, some feel,  is largely still one dimensional. 

Those criticisms may change with an increase in display advertising through the acquisition of DoubleClick (if it passes the increased scrutiny), and increased monetization of video advertising at YouTube but the returns on those developments and from Google’s aggressive spending and investments have largely not hit the bottom line yet.    The coming quarters will be a key test of those investments. 

The coming quarters will also provide more guidance for Google’s spending patterns. So far they’ve spent heavily on long term growth, including regular acquisition costs.  Over the coming quarters that could well continue (Google has over $12.5b in cash and securities on its books).  I wouldn’t be a surprise, for example, if a video search advertising company like Blinkx or YuMe Networks became acquisition bait for them.  

With Microsoft and Yahoo both chasing, what comes next, how much more Google will spend to protect their lead, and when investments will start to yield returns are all questions investors are asking.   Google, in the conference call, as is their practice, was silent on future guidance.  Their actions will have to speak for them.

The stock was down as much as 7% percent in after hours trading.

More detailed press coverage on Google’s finances can be found at:

Yahoo Finance
Google Finance

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