We saw quite a love-fest for Google on Friday following their Q1 earnings release. Given how important this report was for the market and for psychology, it's worth spending a little time on it.
Earlier in the week, comScore released a report in which they estimated Google's paid clicks grew only 2% during the first quarter. Concerns about this slowing had led to a sharp decline in the stock price of Google since the beginning of the year, falling from just over $700 to about $412 last month. With Thursday's earnings release, Google disclosed that its paid click growth actually increased 20% in the quarter. With revenue and earnings coming in above the whisper numbers (GOOG doesn't provide earnings guidance), we saw a huge relief spike in the stock.
There is plenty of positive press out there, so there's really no point in just rehashing it. Let's have a little fun instead and play devil's advocate.
- Even though paid click growth came in well above expectations, the 20% increase is a marked deceleration from last year's 43% growth rate. The bulls and the company argue that this is due to an intentional move by the company to decrease the quantity and improve the quality of presented ads. They hope to charge more for the fewer higher quality ads to offset the volume decrease. When asked about this on the call, management essentially said that the improvements were made later in the quarter, and it was too early to judge their impact. Fair enough on pricing, but then why the decline in paid click growth to 20%?
- ComScore claims that they only monitor US consumer growth, but Google's paid click data includes international. It seems very likely that US growth has matured and slowed dramatically while international growth remains very strong. If so, the fact that the huge US market has slowed so dramatically and so soon should be very concerning.
- Year-over-year revenue growth has been steadily declining.
- The company was adamant that they have seen no impact from the slowing of the economy. I don't really get this. Overall growth at GOOG is clearly slowing, and it appears that U.S. growth is slowing dramatically. How the company can be sure that the economy isn't a factor isn't at all clear. It seems logical to think that the economy has played some role and that growth may have been even stronger had the economy not weakened. Investors are typically less likely to pay a premium multiple for an economically-sensitive growth stock.
- GOOG is trading at 26x this year's EPS estimate. That's not particularly cheap, especially given the slowing growth trends (EPS growth is much lumpier, but it too has been slowing).
- Let's not forget the law of large numbers. Growing $5 billion of revenue at a 40% rate is much harder than growing $100 million at the same pace. Let's make sure expectations are realistic. Were Google to increase revenue at a 40% annual clip, they would overtake the current GDP of the U.S. in just under 19 years. That's not going to happen. As can be seen from the price action of GOOG stock this year, the market doesn't take kindly to strong growth stocks that falter. It's just a matter of time given their revenue base.
- As for this quarter, the company did benefit from a tax rate that was 1% lower than last quarter due to international growth (and weaker US?). That boosted EPS by about 7 cents. Also, though it wasn't discussed, clearly the company was a big beneficiary of the weaker dollar in the quarter. That's fine, but it isn't growth driven by improving operations. So, the quality of the earnings beat wasn't quite as dramatic as the press would have you believe.
I'll be keeping an eye on GOOG and possibly adding a long put position as we move through the quarter should the stock continue climbing and volatility moderate.
