Google (GOOG +2.53%) reported blockbuster earnings results on Thursday after the close, and the stock exploded by more than 13% on Friday to levels above $1,000 for the first time in the company’s history. The good news is that, even after such a huge move, Google has more upside potential for long term investors.
Firing on all cylinders
Wall Street analysts have been concerned about falling costs per click lately, so expectations were generally cautious leading up to Google’s earnings report. But the company proved to the market that it can more than merely offset falling prices with growing volume to deliver consistently robust growth in sales and earnings.
Even if costs per click fell by 8% versus the same quarter in the prior year, Google delivered a 26% increase in paid clicks, and overall revenue increased by a healthy 12% to $14.89 billion versus $14.8 billion expected by Wall Street analysts. Non-GAAP earnings per share grew 21% in the quarter to $10.74, beating analysts' estimates of $10.34 per share.
Importantly, management is quite optimistic about the company’s future as Google looks remarkably well positioned to benefit from the mobile revolution. According to Larry Page, more than 1 billion Android devices have been activated so far, and more than 1.5 million devices are lit up per day. Almost 40% of YouTube’s traffic now comes from mobile; two years ago that figure was only 6%.
The company has recently launched its Enhanced Campaigns allowing advertisers to target multiple devices with a single campaign, and customer response has been encouragingly strong. Google remains the undisputed leader in online advertising, and the company is moving in the right direction to consolidate that position when it comes to mobile.
Like if that weren’t enough, Google is expanding into several areas with considerable long-term potential. Hardware, Google Apps, and futuristic technologies like self-driving cars or augmented reality glasses are just a few examples to consider. Many of these projects will probably have little or no commercial viability, but Google is diversifying its opportunities in several areas with huge potential for growth over years to come.
Valuation
Google is trading at a P/E ratio near 30 times earnings in the last year and 20 times average earnings estimate for the next year. This valuation is reflecting considerable growth expectations for the company, but it doesn't look too excessive for such a high quality business delivering solid financial performance and with extraordinary growth opportunities.
Facebook (FB +1.33%), for example, is trading at a much higher P/E ratio of 200 on a trailing basis and 54 when using forward estimates. The social network is smaller and has the potential to sustain higher growth rates in the middle term. On the other hand, its business model is not as proven and established as Google´s.
Facebook delivered spectacular results for the second quarter, revenue from advertising increased by 53% to $1.6 billion, representing 88% of total revenue. Mobile advertising revenue grew 75% sequentially, and it now represents 41% of the company´s overall advertising, that's up from the previous quarter when it was at 30%.
But a big part of Facebook's success as of late comes from its news feeds ads, a relatively new product that was introduced late last year. The company is clearly moving in the right direction, but it still needs to prove to investors what kind of growth it can consistently generate over time. Facebook reports financials for the third quarter on October 30, and analysts will most likely be putting a lot of attention on mobile revenues in order to evaluate future growth prospects for the company.
In comparison to Google, Facebook may offer higher growth potential in the middle term, but also higher risks and a considerably more expensive valuation.
Yahoo! (NASDAQ: YHOO), on the other hand, is trading at a similar valuation to Google with a P/E ratio of 28.5 times trailing earnings and 20 times average earnings estimate for the next year. At roughly the same valuation, Google is looking like a better deal for investors.
Yahoo! has made a lot of progress under the leadership of Marissa Mayer; the company is attracting new talent and renewing its products. In addition to that, Yahoo!’s 24% stake in Chinese e-commerce portal Alibaba is an enormously valuable asset for the company, and Yahoo! will most likely receive a huge cash inflow when selling part of its holdings after the coming Alibaba IPO.
Yahoo! has recently amended its agreement with Alibaba to reduce the number of shares it's required to sell after the IPO from 261.5 million shares to 208 million, so Yahoo! will now be selling 40% of its stake as opposed to 50%. This is a smart move by Yahoo since Alibaba is providing the growth the company is not generating in its core advertising business.
Revenue excluding traffic acquisition costs at Yahoo! declined by 1% year over year in the third quarter, mostly due to weak performance in display. Unless Yahoo! finds a way to reignite growth in its core advertising business, it makes for a much more uncertain investment than Google in the industry.
Bottom line
Google is delivering rock solid financial performance for investors, and the company is positioned for growth in mobile as well as other business areas with big disruptive potential. Even trading at historical highs, the shares are not too expensive in comparison to other companies in the industry, so it's not too late for investors to ride this high quality growth story for the long term.
