Google (GOOG) recently reported results for Q1 2011 and shares dropped 5% in after hours trading immediately following the results. Although GOOG did miss consensus estimates of $8.10 per share, it was an extremely slight miss of 2 cents. All while revenue increased more than expected, highlighted by the continued success of YouTube advertising. So why are investors reacting negatively? The answer to that question in today's headlines lies in the expense line. Ever since Larry Page took back control of GOOG and Eric Schmidt stepped down, spending on employees and investments has skyrocketed.
However, there is a much bigger issue at work than employee costs. GOOG shares, down 3% YTD coming into today, have been weak. For the last several months there have been continuous reports of top talent fleeing the GOOG campus, with many jumping on with the Facebook team. In a world such as Silicon Valley, we must assume that there is much more in play when key players switch teams than simply higher salaries. The real reason is more likely due to the fact that Facebook is the smaller, less corporate, and just flat out "cooler" atmosphere that Google used to be. In an age where top employee compensation is increasingly issued in company shares, the inside employees are clearly telling us something: Facebook's future appears to be much brighter than Google's. Facebook is expected to double revenues again next year, to $4 billion, and is clearly winning in the display advertising market, which GOOG's Page has admitted to being a key area for future success in the online advertising market.
While none of these issues are brand new, the negative earnings surprises are still negatively affecting the stock. There is obviously still enough optimism in the value of GOOG that investors are selling off shares in response to the slightest miss. It takes a long time for investors to get comfortable with valuing a once high-flying growth stock as they do every other stock. The question investors must now ask themselves is whether or not the risks going forward accompanied with the new normal earnings growth expectations have been fully priced into the valuation?
GOOG currently trades at less than 16x forward year EPS, all while revenues are expected to grow at a 12%-15% annual rate for the next five years, and earnings are still anticipated by analysts to grow 15% each year for the next three years. Even if GOOG has to spend much more on employee expenses and investments going forward to cause the earnings growth rate to drop to 12% a year, the stock still appears to be at least reasonably valued, if not cheap given its dominance in search and the impressive performance of YouTube.
If you are a long term investor, you can probably buy shares of GOOG today, wait five years and be very happy with your return. However, the next several quarters are likely going to be a bumpy ride for GOOG shareholders. Downward revisions to EPS, no matter what the reason, are never positive catalysts for a company in the short term. While fundamental investors may feel this is the perfect opportunity to seize shares in a solid company as a result of an over-reaction to a slight EPS miss, I think there could be more downside to the shares for at least a couple of months as sell side analysts lower their earnings estimates and probably downgrade their shares.