Google Inc (NASDAQ:GOOG)’s early release of its earnings stunned the financial community when it turned out that the pan-technology company had earnings per share come in 15% lower than expectations. Revenue was off as well, coming in 4% lower than analyst consensus. Earnings per share were in fact 7% below the company’s numbers for the third quarter of 2011 despite the intervening addition of Motorola Mobility Holdings. These lower numbers likely come as a shock to hedge funds, as Google (NASDAQ:GOOG) was the second most popular stock among the funds and other notable investors in our database of 13F filings for the second quarter. See the full rankings and learn which hedge funds lost big when Google dropped.
A sizable share of the decline in revenue seems to have been due to lower prices for Google’s paid per click advertising on its search engine results. Paid per click advertising is a high-margin business in any case, and the bottom line is particularly sensitive to changes in pricing. We would also imagine that Google Inc (NASDAQ:GOOG) took some one-time charges as it laid off a number of Motorola Mobility employees in order to realize synergies from the acquisition.
However, we don’t think that holders of Google Inc (NASDAQ:GOOG) should panic. At the $687 figure where Google ceased trading, and annualizing the $9.03 per share in earnings that Google reported for the third quarter, the P/E multiple is 19. That’s not good enough to warrant pure value status, but if Google is able to grow its business from this past quarter then between that, its attractive brand, its good position in smartphones and tablets (though this has not proved particularly profitable for now), and the colossal portfolio of real options that it has been building for itself it could see its stock price rebound.
There’s at least some reason to think that future quarters will be at least slightly better than the company’s recent performance. We’ll take a close look to see what the effect on Google’s earnings of any one-time events have been; that could prove a source for improvement. In addition, recent good news on the macro front- ranging from retail sales to consumer confidence to home starts- suggests an improving U.S. economy, which in theory could hold advertising rates steady or drive them back up. The bear case is that the decline of pay per click rates is driven not only by concerned advertising budgets but also a revelation in the industry that online ads are not as valuable as had been thought (along with an increasing move to use of mobile devices, where ads are harder to monetize). In addition, Google Inc (NASDAQ:GOOG) insiders including both Larry Page and Sergey Brin both sold a number of shares earlier this month (read more here); the sales were pursuant to a 10b5-1 plan and therefore not something that Page and Brin actively decided to do, but is a bit discouraging.
Google’s rivals Apple Inc. (NASDAQ:AAPL) and Microsoft Corporation (NASDAQ:MSFT) both trade at 15 times trailing earnings. Microsoft’s multiple is skewed a bit upward due to some one-time charges in the second quarter of the year; its core business is certainly not expected to grow as quickly as Apple’s. On a forward basis, Microsoft’s P/E is 9 (though in this case analyst consensus is likely skewed towards higher earnings as new versions of Windows and Office are sold) and Apple’s is 12. Even though Apple has had its own problems recently, a trailing P/E of 15 for a large, growing company with a strong brand seems like it might be too low. Microsoft, too, has a number of these advantages (to a lesser degree) and a dividend yield of 3%.
Yahoo! Inc. (NASDAQ:YHOO) and Facebook Inc (NASDAQ:FB) are two other Internet players supported by advertising. Yahoo carries a trailing P/E multiple of 18, and its revenue and earnings were actually declining in the second quarter compared to the same period in 2011; we think that if pay per click rates are down, that should hit Yahoo as well and that company does not have as many advantages as Google. It probably shouldn’t trade at that light a discount. Facebook, even after the drop in its stock price since its IPO, trades at 31 times forward earnings estimates. Revenue was up strongly in its most recent quarter versus a year earlier, but the social network is likely running out of avenues to expand its user base and does not seem to have a monetization strategy beyond advertising. We don’t think it’s a good short anymore, but wouldn’t be long at these prices either.
There’s room for Google Inc (NASDAQ:GOOG) to improve its performance going forward, and to see at least somewhat higher earnings in its next couple quarters. However, with advertising possibly becoming a significantly poorer business model- as seems to be demonstrated by its quarterly report- it might not be as good a buy as Apple and possibly Microsoft as well, even after the decline in price.
