Is Google’s Earning Growth Slowing Down?

  • Slow growth in major search metrics are a source of worry.
  • Higher expenses in R&D and marketing are taking a toll on margins.
  • Future growth possibilities within the firm.
  • How the earnings affect the valuation.

Google’s earnings growth has shown a marked decreased in the past couple of years. Google’s stock analysis shows that this decrease can be attributed to changing market dynamics, move towards a lower search based environment, higher spending requirement and saturation of the market. Still Google has been able to muster some decent numbers in its Q4 earnings which include a 15.9% increase in revenues year-on-year to $18.1 billion.

Slow growth parameters

GOOG stock analysis requires an understanding of the basic search metrics. Keeping the financials aside some of the search parameters show a worrisome picture about the entire industry. Search still forms an overwhelming portion of revenues for the company. 20.5% of revenue is generated by the ad network and 68.5% by Google sites within which search forms a major portion. Hence any slowdown in the search metrics would be a death knell for Google. In 2014 the paid click growth slowed to 20% down from 25% in the previous year. The cost per click (CPC), another very important search metric, declined by 5% which shows that the topline growth in Google should be heading to an era of low growth. It is taking measures to stem the tide of this decrease.

google cpc and clicks

Fig: Decline in CPC in the past few quarters.

Higher expenses

Another issue for most of Google stock investors is the spiraling costs within the firm. The company has increased its R&D efforts greatly and is moving into newer space like Internet of Things, driverless cars, robotics, smart home and more. These ‘moonshots’ end up costing a huge chunk of expense thus reducing the margins. In the past few years, the net margin of Google has declined a whopping 800 basis points from 29.01% in 2010 to 21.1% in 2014. Although still highly profitable one has to look at its low tax rate of 19.3% which was much lower than other counterparts like Apple.

Due to stricter regulations if the tax rate jumps back there will be an additional hit on the net margins. These lower tax rates are possible by routing of their income through tax havens. Although perfectly legal there is an increasing clamor in different countries like UK to plug this gap which could cause an increase in the tax rate.

digital video ad spend

Fig 2: Rise of digital video ad spend in the past few years.

This year the digital video segment is stated to grow by over 30% against 3% growth for TV. This huge difference will provide a healthy boost to Youtube which leads in online digital video consumption. According to research firm Jefferies the revenue of Youtube in 2014 was around $2.8 billion and is estimated to increase to $3.5 billion in 2015. (Google does not disclose revenues for Youtube separately)

It is also making a play to gain better talent and invested sizable amounts to help in the production of original content. Youtube is also looking to launch a new service by the end of 2015 which will finance the programming of the content from its popular video creators.

Although it still forms a small portion of the total revenues there is a huge growth potential in this segment. Getting a sizable market share and developing stickiness for both the viewers and creators would lead to a solid revenue stream for a long time.

Google X

Google has been known to invest in newer products and technologies both by developing them in-house and acquiring new startups. These non-core projects lead to products which can fuel the next growth phase for the firm. For example although a driverless car might seem a totally unconnected investment it can still provide good “mini-products” which are developed within this project. A major issue is about the justification of expenses and the management in its latest earnings report laid out a sustainable approach which they use to green light these projects and provide additional funding after achieving of milestones.

However its acquisitions have not been as fruitful in the recent past. While facebook has invested huge sums in acquistions like Instagram and WhatsApp which have provided good synergies Google is yet to show a similar acquisition. Even the acquisition of Oculus Rift by Facebook showed the new segments which the firm is ready to explore whereas Google hasn’t shown similar audacity in the past few years.

Future Direction

With a growing move towards social media and applications the need for search engines would reduce eventually. This is a mass shift which will reduce the core growth of Google. Before a massive change happens it will have to create additional revenue streams within which it can be a market leader. This will need a greater chutzpah from it and a higher agility to acquire newer startups.

Conclusion

The current valuation of 19 times P/E in forecasted GAAP earnings shows that the firm is not overvalued. GOOG stock analysis shows that until there are substantial signs of high growth products the overall trend of the stock would be passive. The stock had a subdued 2014 showing a fall of 6% against a 12% return shown by S&P500. 2015 looks like a similar year with moderate growth in earnings and a stagnant stock price.

About the author

Rohit Chhatwal is a Financial writer who has over 4 years experience in the finance field. His main areas of interest are value investing and macroeconomic analysis.
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