Source: Google
Investors are not very excited about Google (GOOG -1.96%) (GOOGL -1.97%) stock lately: Shares of the search powerhouse have fallen by 13% from their highs of the year, as the company delivered disappointing results for the last quarter and investors are becoming increasingly worried about the competitive risk that Facebook (META -10.56%) represents.
On the other hand, Google is still a rock-solid player in the much promising online advertising industry, and current valuation looks like an attractive entry point in such a profitable growth company.
The challenges
The online advertising industry is inherently dynamic, and it's gone through important changes over the last several years. The mobile computing revolution is offering enormous potential for growth, as global consumers are spending an increasing amount of their time online via multiple screens. However, growing supply is having a negative impact on ad prices, which is a negative factor for Google.
In addition, Facebook (META -10.56%) is growing at full speed, proving that not even a massive juggernaut like Google is immune to competitive risk when operating in such a vibrant industry.
The social network founded by Mark Zuckerberg announced a jaw-dropping increase of 59% in revenues during the third quarter of 2014, reaching $3.2 billion during the period. Mobile advertising revenues accounted for nearly 66% of Facebook's advertising sales in the period, a big increase versus 49% in the same quarter last year.
In this context, Google delivered lower than expected sales and earnings for the September quarter. Sales during the period grew 20% year over year to $16.52 billion, paid clicks increased 17% and average cost per click, which measures how much money Google makes per click, declined 2% versus the same quarter in 2013.
While this is clearly an impressive growth rate for a company as big as Google, sales were marginally below Wall Street expectations. In addition, Google is heavily investing in human talent and technology, and this is putting downward pressure on profit margins. Operating expenses represented 37% of revenues during the last quarter, an increase versus 33% of sales in the same period last year.
Adjusted earnings per share came in at $6.35, a 13% annual increase, but lower than the $6.53 per share forecasted on average by Wall Street analysts.
The opportunity
Wall Street does not appreciate disappointing earnings, especially when coming from a high growth company such as Google. However, short-term negativity can sometimes create long-term opportunities for investors, and this seems to be the case when it comes to Google stock.
After all, the company is still the undisputed leader in search, according to estimates by comScore, Google owns 67.3% of the U.S. search market. This is a big plus for investors, as search is very powerful in online advertising due to the relevance and placement of the ads.
The mobile revolution is changing the landscape for different players in the industry; however, Google is second to none when it comes to competitive position in that area. Based on IDC data, Google's Android mobile operating system powers a massive 82.3% of smartphones around the world. In addition, the company owns many of the most popular apps for iOS, which secures Google's privileged position in the mobile computing paradigm.
Google is building a gargantuan empire of strategic assets across the Web, including properties such as YouTube, Chrome, Google Maps, Google Play, and Google Docs, among many others. This shows that the company has an almost indestructible competitive position in the industry, protecting its profits and setting the stage for growth in the coming years.
Facebook is growing much faster than Google, but the social network has a revenue base of less than 20% of Google's sales based on data for the last quarter, so growth rates are not a fair comparison. Besides, just as the traditional advertising industry has provided enough opportunities for different companies to do well over time, online advertising seems to be offering abundant room for both Facebook and Google to thrive.
Google trades at a forward P/E of 17.8, roughly in line with the average forward P/E ratio of 18 for companies in the S&P 500 Index based on Morningstar data. Even if growth slows down, Google will most likely outgrow most companies in the index by a considerable margin in the coming years, so current valuation looks quite attractive.
The company is a high quality business with rock-solid competitive strengths and exciting growth prospects. The market seems to be shortsightedly focused on the company's disappointing performance last quarter, and this could create a buying opportunity for strategic long-term investors.
