Google Q2 Solid; Wall Street Overreacts to "Earnings Miss"

Oh, yes, Wall Street panicked--that's new. It's hard to say whether the 7% aftermarket plummet was the result of margin slippage (the popular story) or the stock just having been too damn high in the first place, but all the hand-wringing about an "earnings miss" is almost certainly an overreaction.

Google's (GOOG) expenses were higher than expected (see conference call transcript) because:

1) They hired more people than they planned to, and
2) They changed the way they account for bonuses, which required a "catch-up" from Q1.

The second factor is a one-time item that is unrelated to the company's performance (translation: It's irrelevant). The first factor, the "over-hiring," could indicate a problem, but only if you believe Google's management is full of it.

Companies generally "overspend" for one of two reasons. Either they spend according to plan but their revenue falls short and they try to hide it by blaming spending (which is bad, especially for a growth company like this), or revenue comes in where they think it will and they actually just...overspend.

Google's revenue performance in the quarter was just fine--a steady, modest deceleration in year-over-year growth, with weakness in the Adsense network and exceptional strength on the far-more-profitable Google.com. Eric Schmidt also said quite clearly that the company simply hired more people than it expected to. So, in this case, the "overspending" was quite likely the benign, one-time kind.

Free cash flow, meanwhile, is continuing to grow again, after more than a year of stagnation while the company poured billions into data centers, servers, and real-estate. At a current run-rate of about $2.6 billion, Google should exit the year with about $3 billion in free cash flow. Now that the stock is back in the $500-range (Wall-Street's aftermarket fibrillation having sliced $20 billion off the market cap), that translates to about 50X-55X free cash flow. Expensive. Not outrageous, but expensive.

And we would be remiss if we did not once again take the opportunity to step back and gape in awe at a company that didn't exist 8 years ago now generating $15-plus billion in annual revenue and $4 billion in profit, all from organic growth.

GOOG 1-yr chart

Comments

[Sufiy:]

Google GOOG Earnings and Growth are Falling further
The most important ring bell for all Google shareholders should be falling by 12% margin from almost constant before 33% to 29% of revenue. With increase in revenue of 58% Y/Y Google demonstrated falling growth rate of -25% Y/Y. Google network growth is falling even more faster by -38% Y/Y due to heating up competition. Net Income actually fall from 1billion to 0.9 billion comparing to the 1st q 2007. Total cost and Expenses are growing 116% faster then revenue growth rate Q/Q. Sales per head is down by -6%. With all this deteriorating fundamentals investors still were ready to pay last Thursday 548.59 which brings Google to valuation of P/S=12.9, P/E=47, P/FCF=74. Even if Google could
sufiy.blogspot.com/200...

2007 Jul 20 09:01 AM

[bill.powelson:]

Henry, you are right on.

2007 Jul 20 10:37 AM