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Summary

  • Google faces some troubling market trends.
  • Reliance on traffic from owned sites is a problem in the social media world.
  • The search giant will start facing the law of large sizes.

The biggest thesis surrounding investing in Google [(NASDAQ:GOOGL), (NASDAQ:GOOG)] is that the company has a dominant position in search that will capture a large portion of the shift of advertising spending towards the digital space. Naturally, the company controls the desktop ad market due primarily to search, but increasingly traffic is moving to other mobile app sites that could quickly choke off Google's access to users' search for businesses.

In reality, Google is now reliant on a couple of internal properties to deliver the majority of profits. The company has potential to grow the mobile operating system business and even wearables, but the stock isn't going anywhere unless it maintains the numbers in search. The primary concern is that the company is increasingly seeing a lack of growth in network traffic. First though, let's review the recent results and discuss the shift towards mobile ad spending.

Q214 Numbers

By all accounts, Google is producing exceptional revenue growth though the earnings misses are starting to mount. The global search leader grew revenue by 22% over the prior year period to reach nearly $16 billion. Very impressive revenue growth for a company with a revenue base exceeding $60 billion. In reality, the earnings glitches of the last 3 quarters are more an issue of properly keeping analysts on target with operating margins staying flat at 32% over the period. The EPS surged from $4.96 in Q213 to $6.08 in the last quarter. So clearly the numbers are solid despite the misses.

The biggest issue is the slow growth from network sites. For the last quarter, revenue unrelated to Google owned sites such as google.com and YouTube only grew 7% YoY and 1% QoQ. See the chart below from the Q214 presentation:

In addition, the paid clicks growth for network sites is substantially below owned sites. Its a further sign that Google isn't capturing the major growth areas of social media.

(click to enlarge)

Mobile Ad Spending

The biggest issue with mobile is users go directly into apps for data and bypass searching on Google properties in the process. In addition, Facebook (NASDAQ:FB) is increasingly pushing into the search realm hoping to take advantage of the massive user base of over 1.3 billion monthly active users. Personally I doubt the service will take search queries directly from going to google.com, but Facebook already claims over one billion queries per day. The real question is whether the queries are for a local plumber or searching for a friend or maybe a celebrity page. One involves a potential financial transaction and the other doesn't.

eMarketer forecasts a dramatic increase in mobile revenue for Facebook and even Twitter (NYSE:TWTR) that will eat away at Google's market share over the next couple of years.

The above graphic doesn't even show services like Yelp (NYSE:YELP) that were built to replace the generic searches on Google. Why go to google.com to find a random service provider, when a mobile app like Yelp will tell you the best and closest services to the users current location.

Conclusion

For now, Google continues to see substantial growth due to the shift of advertising spending to digital forms that benefit the company. The constant shift towards mobile though is leading to material market share losses. By 2018, eMarketer forecasts the mobile ad market to only grow 22.2% and one can undoubtedly expect Google to see smaller growth as all the other services eat away at the share. At about 22x earnings, the stock is too expensive for a stock of that size and a shift in the market will erode market share over time.

Disclosure: The author is long YELP. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained herein is for informational purposes only. Nothing in this article should be taken as a solicitation to purchase or sell securities. Before buying or selling any stock you should do your own research and reach your own conclusion or consult a financial advisor. Investing includes risks, including loss of principal.