Buy Google on its Earnings Dip?

Breaking down why Google’s earnings miss might not be a bad thing for investors.

Andrew Tonner
Andrew Tonner
Apr 21, 2014 at 1:00PM
Technology and Telecom

Even the best companies in the world must endure their fair share of short-term headwinds, and that's exactly what investors are seeing play out at search giant Google (NASDAQ:GOOG) (NASDAQ:GOOGL) lately.

The search giant's shares have been sinking more than the overall market over the last month of so. But, Google's near-term problems were compounded last week when Google missed meeting analysts' estimates in its Q1 '14 earnings report.

For those keeping score at home, the high-level themes driving Google's financial performance remain largely unchanged from past quarters. Most importantly, Google is still trying to manage transitioning its money-making machine onto mobile, which has been a near-term drag on Google's financials. Thankfully, Google isn't alone in dealing with some of these kinds of business issues. Chinese search giant Baidu (NASDAQ:BIDU) is also trying to navigate these same problems, making this more of an industrywide trend versus a company-specific issues unique to Google alone.

So, keeping this in mind, let's actually take a look at Google's results to see what investors should take away from Google's recent report..

Google by the numbers

Let's start with the goods news: the company's growth story remains largely intact.

In the first quarter, the global search giant raked in $15.4 billion in sales, which represents an impressive 19% increase over the same quarter last year. It's probably worth noting how uniquely special that last statement truly was.

Source: Google

There aren't many companies that can continue to grow their business at such above-average rates with such a large sales base, which speaks to how special Google truly is. But, I digress... 

Looking further down Google's income statement, the ugly truth becomes evident. Profit growth simply couldn't keep pace with revenue growth. As a result of two different dynamics I'll touch on in a moment, Google's net income increased only 3%. However, there's a lot going on between the revenue and profit sides of Google's economic machine, and some of the costs that help stifle profit growth aren't necessarily bad things. 

Most importantly, we saw one of the main dynamics we've seen at work with Google over the last several years play out once more: Google's profit per advertisement continues to fall. It's also where the Baidu comparison becomes instructive. As a result of Android's ubiquity, mobile ads have been fueling powerful ad growth at Big G, with paid clicks surging 26% during the quarter. But, because mobile ads monetize at lower rates than Google's desktop ad business, the revenue generated on an average per-ad basis, known as cost per click or CPC, declined 9%. 

It's also worth noting that Google is expanding into new forms of advertising, like display ads on YouTube for instance, which monetize at lower rates than search-based ads. We've seen this dynamic play out with Baidu as well over the last several years, but to me, there's a significant silver lining here for the likes of Google and Baidu. Sure, they amount they're making today on mobile search ads is lower than investors would like at both Google and Baidu, but both Google and Baidu have moved quickly to expand their dominant search engine businesses into the de facto search engines on mobile. Seeing their CPCs drag as mobile ads as a whole absolutely explode at Google and Baidu seems like a fair price to pay in the short-term if it means Google or Baidu will get to maintain their dominant places at the epicenter of one of technology's most profitable business models.

It's also worth noting that Google also ramped up other one-time investments during the period as well, which dragged on its bottom line. For instance, Google noted that recently acquired Nest drove up R&D expenses during the quarter, and there are plenty of other examples of Google's investment spending on items like driver-less cars and Internet-deploying drones that also eat into profits. Apparently, creating the future is expensive business.

Is Google a buy on the bad news?
The most important point to focus on is that Google's in the midst of an expensive, but necessary, transition into new areas of technology. Ultimately, opening new revenue streams should mean a lot more money for Google and its investors. I'm still an unabashed Google fan as an investor, so I'm writing-off this report as Google largely having to endure the costs required to invest in a more bountiful future.

In general, the big picture matters orders of magnitudes more than a short-term blip, and I believe that's the case specifically with Google today. With a future as bright as Google's, almost any pullback in its stock price creates a more attractive entry point for investors, and tech investors would do well to take a look at Google while it remains down.