3 Reasons to Worry About Google's Earnings

We're now just two days away from Google's (Nasdaq: GOOG  ) second-quarter report.

The world's leading search engine certainly has a lot of things working in its favor. Despite a few territorial misses -- losing out to Yandex (Nasdaq: YNDX  ) in Russia and Baidu (Nasdaq: BIDU  ) in China -- Big G is the undisputed global champ.

The high-margin nature of paid search, and the growing number of Internet users worldwide, have played out well for Google in the past. The company kept growing its top line even during the darkest recessionary stretches. Shareholders have also made out nicely; the stock has risen sixfold since going public seven summers ago.

However, there are a few reasons to be concerned heading into Thursday afternoon's report. Let's go over three things in particular that should trouble investors.

1. The trend isn't Google's friend
Google has beaten Wall Street's profit expectations in nine of its past 11 quarters. Unfortunately, the two misses have come over the past year, including its most recent first-quarter whiff.

There's another trend working against the dot-com giant. Forward estimates -- which historically inch higher for perpetual market thumpers -- are going backward.

Prediction

2011 Estimates

2012 Estimates

Current $33.86 $39.31
7 Days Ago $33.83 $39.33
30 Days Ago $33.93 $39.53
60 Days Ago $33.90 $39.44
90 Days Ago $34.61 $40.09

Source: Yahoo! Finance.

Analysts are expecting Google to earn 2% less this year and next year than they did three months ago. This may not seem like a big deal, but these figures used to inch higher week after week during the company's early years as a public company.

2. Pessimism is growing
Morgan Stanley downgraded shares of Google on Friday.

Who does that? Who would talk down a company less than a week before a critical quarterly report? Analysts do some pretty stupid things, but only those with the strongest convictions usually do something as brazen as this.

Morgan Stanley's Scott Devitt also slashed his profit forecast on the company. He now sees Google earning $31.44 a share this year and $34.43 a share come 2012. That falls well short of the wider market's diminishing estimates, not to mention the $32.73 and $37.58 in per-share profitability, respectively, that Devitt previously predicted.

He's concerned that the company's margins are in for a bruising, given corporate spending run amok. Ambitious hiring and new product launches will definitely take a big bite out of earnings. Is it any wonder the pros are treating Google estimates like a limbo stick?

3. Good news may be bad news on the bottom line
There's no shortage of buzz for Google+ as a potential Facebook killer. Android continues to widen its lead over Apple's (Nasdaq: AAPL  ) iOS as the smartphone operating system of choice. Google Offers is no Groupon, but it's hard to underestimate Big G's Rolodex.

Think about the companies leading these industries. We don't have Facebook's financials, though China's leading social-networking site -- Renren (NYSE: RENN  ) -- is losing money. Groupon is gushing red ink. Android is being given away, so it will never be the profit beast that Apple harvests with its proprietary platform.

There are also some likely misses in Google's product bag of introductions over the past year.

The Chromebook will have an uphill battle in its quest for relevance. Despite big-name hardware partners like Sony (NYSE: SNE  ) and Logitech (Nasdaq: LOGI  ) , Google TV hasn't moved the needle.

All of these winners and potential losers must be costing Google a lot of money now, even though they may never make Google a whole lot of money later.

Google's best play was its first play -- paid search. Everything else will likely eat at its once-lofty margins. Why else would analysts target revenue growth of 26% this year and 21% next year, yet hold out for profit growth in the midteens both years?

Google will remain a great company for a long time, but its bottom line will face challenges in the coming quarters -- and those challenges start Thursday.

Would you buy or sell Google ahead of its quarterly report? Share your thoughts in the comment box below.

The Motley Fool owns shares of Apple, Google, and Logitech International SA. Motley Fool newsletter services have recommended buying shares of Google, Apple, Baidu, and Logitech International SA. Motley Fool newsletter services have recommended creating a bull call spread position in Apple. Motley Fool newsletter services have recommended creating a write covered call position in Logitech International SA. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Longtime Fool contributor Rick Munarriz still uses Google a lot in his daily life. He does not own shares in any of the companies in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (7)

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  • Report this Comment On July 12, 2011, at 1:44 PM, dstb wrote:

    I'd say that the analysts becoming more pessimistic is a good thing for Google. I agree that margins and expenses will probably not look good this quarter but if it is already factored in then we don't have much to worry about.

  • Report this Comment On July 12, 2011, at 2:06 PM, Uruzone wrote:

    Personally, I've never owned Google because, like Amazon, it's a stock I never really understood. Google is, in my opinion, the absolute best in its field at one thing -- search. It has stayed there because it continuously innovates on this front as well as on the money-making opportunities that surround search.

    Very few companies with as strong a core in one product branch out successfully into new areas, so I agree that Google is bound to lose money on almost every front except search. (Social media may actually be an exception for them in the end, because their search ecosystem has already given them so much demographic information about their users that -- if it's managed properly -- Google Plus will give Facebook a serious run).

    Apple has always been a software AND hardware manufacturer, so even though they've forayed into media players and phones, these are simply extensions of their core competencies. Consequently, they've been successful on these fronts.

    Microsoft had always been a software-only company, and though the Xbox is an undeniable success, the Zune and a variety of tablets have all been failures because they stray too far from core competency. Even Bing is stagnating at around 14% of market share. Not bad, but not what one would expect from Microsoft.

    Google has deep pockets, and it's good that they are experimenting. But giving away Android runs counterintuitive to everything one learns in business school. Free trials? Sure. Free forever? Idiotic. Google has spent millions developing software to which anyone can have the source code in order to build their own hardware.

    So let's review: Apple makes hardware and software, and charges for both.

    Microsoft makes software and charges handsomely for it.

    Google gives away software and doesn't make money on the hardware that's produced. Can the money they make from licensing for Android Market possible compensate for that? I personally don't think it can.

    In the end, all this serves to do is eat away at profits in the search engine sector.

    It's absolutely possible that they will pull out a success (meaning they will earn money, not just market share) in other ventures as Microsoft did with Xbox. But because I can't see a clear path to how they would do it, I continue to avoid purchasing the stock. Consequently I would sell GOOG ahead of earnings.

  • Report this Comment On July 12, 2011, at 2:32 PM, khaledmrd wrote:

    New Gen Google TV new w/Android OS means USB support which means more accessories like for gaming, Screen resizing and Android Store expected summer

    Chromebooks for Office could be great in the Cloud computing and Virtialization era, expect success if you add to it Office Unified Communication Video, Audio, presentation and in many industries like Education

    Android Smartphones & Tablets just the begging

    The big next thing is is Google Digital Home

    Companies that will benefit could be Symentic, Logitech,Western Digital

  • Report this Comment On July 12, 2011, at 2:34 PM, Davewrite wrote:

    "Android continues to widen its lead over Apple's (Nasdaq: AAPL ) iOS as the smartphone operating system of choice"

    android growth doesn't necessarily equal profits.

    Google says it will earn $1 to 2 billion a year off all mobile profits (including electronic payments, search, ads etc). A sizeable chunk of that will be from iOS as Google is default search on Apple devices. 1 to 2 billionis gross, minus R&D, support, promotion and Android profits is chickenfeed.

    Android marketshare includies variants like OMS in China that don't run Google services and phones that run Yahoo, Bing, and bidu and have their own non google app stores.

    In comparison Apple will easily make over $50 b off mobile a year ($10 billion a quarter from iPhone alone before iAds, iPad, app store etc)

  • Report this Comment On July 13, 2011, at 3:21 PM, Gregeph wrote:

    Beating earnings expectations and pessimism by the street are not what serious investors should focus on. The real meaningful questions are: 1) does Google have a durable competitive advantage (Buffett's moat), 2) does it have strong growth prospects, and 3) is it available at a good price?

    Regarding the second question, Google is benefiting from four huge secular waves. This first is the continued increase in Internet usage around the globe. The second is the ongoing increase in online advertiser spending. The third is the rise of mobile Internet usage. Cisco projects that global mobile data traffic will increase 26-fold between 2010 and 2015. The forth is the massive amount of new data that will continue to be placed on the Web. This will only accelerate as more and more devices are connected to the Internet. This will benefit Google because it will make Google’s core search engine more valuable.

    For more see the following blog posts:

    "Charlie Munger on Google’s moat – it’s huge … probably widest he’s ever seen" http://gregspeicher.com/?p=2570

    "Does Google deserve a high multiple?"

    http://gregspeicher.com/?p=2840

    http://gregspeicher.com/?p=2876

  • Report this Comment On July 13, 2011, at 4:47 PM, Jay456 wrote:

    I do not like trying to figure out reasons for analyst-think, and I like reading articles about it even less. Let's stick to the business, not so much how it's viewed by analysts...and why.

    As I'm sure the author doesn't need me to remind him, in Fool-land it is widely believed that paying attention to stock analysts is a fool's game.

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