Shares of Google Inc (GOOG) have seen a modest correction after the release of the company's second-quarter results last Thursday, July 18. Yet it seems like only a matter of time before shares of the most popular search engine will break through the $1,000 mark. While short-term earnings are under pressure, that's because of "overinvestments" in the company. Google is sacrificing short-term profits to further boost the company's ecosystem, which drives long-term shareholder value.
Google generated second-quarter revenues of $14.11 billion, up 19% from the year before. Revenues missed the $14.42 billion consensus estimates. Net earnings rose by 16% to $3.23 billion. Consequently, earnings per share rose to $9.54 per share. Discontinued operations added $674 million, or $1.99 per share, in profits during the quarter. Still, earnings missed consensus estimates, which stood at $10.42 per share by a wide margin.
CEO Larry Page commented on the performance over the quarter:
Google had a great quarter with over $14 billion in revenue -- up 19% year on year. The shift from one screen to multiple screens and mobility creates tremendous opportunity for Google. With more devices, more information, and more activity online than ever, the potential to improve people's lives even more is immense.
A Deeper Look Into the Results
The majority of consolidated revenues were generated by Google revenues. Its own sites reported $8.87 billion in revenues, up 18% on the year. Network revenues rose by 7% to $3.19 billion, while other revenues more than doubled to $1.05 billion.
The number of paid clicks rose by 23% vs. the year before and were up by 4% on a sequential basis. More importantly, the big disappointment was that costs per click fell by 6% on the year, and by 2% on the quarter. Traffic acquisition costs came in at $3.01 billion, or 25% of total Google revenues, which is unchanged vs. the year before. Revenues from Motorola Mobile rose to $998 million, up from $843 million last year.
Overall, income from operations fell by 3.5% to $3.12 billion. Earnings have been falling on the back of higher cost of goods sold, a rapid increase in research and development, and a general increase in all other costs.
Google ended its recent quarter with $54.4 billion in cash, equivalents, and short-term investments. The company operates with $5.0 billion in total debt, for a net cash position of around $49.4 billion. For 2012, Google generated revenues of $50.2 billion, up 32% vs. the year before. Net income advanced by 10% to $10.7 billion.
Trading around the $900 mark, the market values Google at $297 billion. This values operating assets of the firm around $248 billion. As such, Google's operating assets are valued around 4.9 times annual revenues and 23 times annual earnings. Despite the solid cash balances and the immense profitability of its operations, Google does not pay a dividend at the moment.
Some Historical Perspective
Early investors in Google's public offering have seen incredible returns. Shares rose from merely $100 in 2004 to highs of $700 by 2007. After falling toward $250 in 2008, shares have seen a steady recovery to current levels around $900 per share. Between 2009 and 2012, Google has more than doubled its annual revenues to just over the $50 billion mark over the past year. Net income advanced by roughly two-thirds to $10.7 billion.
The main disappointment in Google's earnings report was the fact that cost-per-click fell by 6% compared to a year earlier and was down 2% on the quarter. These rates indicate how much advertisers pay Google every time an Internet user clicks on an ad on one of its websites. The reason behind falling rates has been the increased usage of mobile phones and tablets, which carry lower revenues per click. This is as advertisers see a reduced conversion from advertisements on these devices into actual sales.
Analysts were looking for a 3% drop on the year before. However, Google is already changing its Adwords package to sell advertising on combined rates for PCs, tablet and mobiles combined. While analysts were already hoping that changes to its advertising system, known as "enhanced campaigns," would slow down the fall in cost-per-click, this has not become reality yet. Still, the real effects will be seen from now onward with 6 million campaigns, or about 75% of all active campaigns having been upgraded to enhanced campaigns.
Still, I am not worried about the earning miss. Google stepped up its research and development efforts to 14% of total revenues. This means it could generate billions more in short-term profit if it wishes to. Instead, it researches many ideas and invests heavily, including some focus groups on ideas that can change the world, including the self-driving car.
Just like its competitors, Google is building its ecosystem and has been successful enough to freely give its operating system Android away. Instead, it opts to make money from people using Android to search on Google's websites or watch YouTube videos. The installed Android base increased to 900 million devices, and the company is on track to breach the 1 billion mark in a month or two. The troubled Motorola division, which continued to report losses, is set to release its Moto X phone, which is highly anticipated both internally and externally.
Similar to Amazon.com (AMZN), Google is overinvesting at the moment as it could boost short-term profitability much more if needed. The company is building a strong ecosystem with Android, YouTube, Motorola, Chrome, Adwords, and many more ideas. The valuation at 23 times last year's earnings is a bit high, but future prospects continue to look good as current earnings are under pressure from overinvestment. I would expect to see shares move toward the magical $1,000 level later this year.