Google Earnings 101

If the stock market hates anything, it's uncertainty. When investors can't get a grip on a company's business model or news flow, share prices tend to plummet.

And Google (Nasdaq: GOOG  ) sure moves in mysterious ways. The precocious 10-year-old raises eyebrows with every move, leaving the stock price well below what the company really is worth. So, on the eve of Big G's second-quarter earnings report on Thursday night, I think it's time to paint a clearer picture of what the company is doing.

Not the Google you think you know
Everybody knows Google, the king of online search. It's true that Google has a stranglehold on the search market, no matter how hard Microsoft (Nasdaq: MSFT  ) , Yahoo! (Nasdaq: YHOO  ) , and assorted upstarts try to usurp the ruler. And the Web traffic flowing through Google Search is a powerful revenue driver.

But it's far from the only thing Google does, and arguably not even what it does best. That honor would fall to the fearsome twosome of online advertising: AdWords and AdSense.

How does it work?
The Ad brothers are two sides of the same coin. Publishers use the AdSense system to place Google-powered ads on their websites (or in news feeds and Web videos, or even online games) and gain a pittance for every user clicking on the ads. Advertisers go through AdWords to plan and design their ad campaigns -- and to feed their pitches through to the waiting AdSense publishers.

It's an open auction system where advertisers outbid each other for a spot on the page you're about to see (and Google keeps a modest cut of the auctioned ad rates). This is why Google's Hippocratic oath to "do no evil" is so important: If the users don't trust Google, they won't click on the ads. If advertisers didn't trust the company, there'd be no ads to begin with. As long as Google's advertising revenue keeps growing, then, you can safely assume that most people generally trust Google.

What's the frequency, Kenneth?
Industry analysts disagree on how Google's quarter turned out. Most agree that the number of clicks kept up decent growth of 13% or more over last year, but the average cost per click may have gone up, down, or stayed the same. But don't worry too much about those finer points: Google won't tell us how that equation breaks down anyhow.

What's important, and possible to divine from third-party sources, is that the ads keep flowing and revenue keeps growing. And Google has an unblemished record of year-over-year revenue growth, stretching all the way back to the IPO in 2003 and probably beyond. Yes, that includes last quarter, when the darkest days so far of this recession had to beat numbers from early 2008, when everything was still hunky-dory.

The bottom line
I see no reason to doubt that Google will get back to its longstanding habit of crushing Wall Street estimates and pessimistic outlooks Thursday night. Industry research firm SearchIgnite says that Google stole some more share in search advertising from Yahoo! and Bing. So the fact that overall online advertising shrunk a bit shouldn't be enough to bring Google's growth figures into the red.

And don't forget that the battle for ad clicks is fought over many battlefields. In just the last three months, Microsoft has relaunched its search service, Google announced an operating system and a game-changing communications product, and Yahoo! picked up a failed Google project -- to make it a standard feature in all its searches.

Google might score a home run with its Linux-based operating systems -- be it Android on Motorola (NYSE: MOT  ) smartphones or Chrome on Hewlett-Packard (NYSE: HPQ  ) notebooks -- and become the next Microsoft. Or it could buy Twitter with a fraction of that $17.8 billion cash hoard, meld it into Google Wave, and become ... well, Verizon (NYSE: VZ  ) and AT&T (NYSE: T  ) spring to mind, but there's really no historic equivalent for such a beast.

Just don't forget that Google is a living, breathing monster fueled by goodwill toward men and the heart of an advertising giant. Its best days are way ahead, and Mr. Market sorely underestimates the value of this cash-generating machine.

Further Foolishness:

Google is a Motley Fool Rule Breakers recommendation. Microsoft is a Motley Fool Inside Value pick. Try any of our Foolish newsletters today, free for 30 days.

Fool contributor Anders Bylund owns shares in Google, but he holds no other position in any of the companies discussed here. You can check out Anders' holdings or a concise bio if you like. The Motley Fool isinvestors writing for investors.


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