Earnings Preview: Will Google Perform?

On Thursday, Google (GOOG) will report its Q1, 2008 earnings. There is rampant speculation about whether Google will perform, and with April options expiring one day after earnings are released, we can get get a sense of what the investing population thinks as a whole.

Call options are slightly higher than put options, suggesting that the market believes they will perform well and the stock will edge higher after earnings are announced. Once again, I am a contrarian and believe the shorts have it right. Why? There are several reasons why I believe Google will disappoint:

Ad revenue, the main driver of Google’s earnings power, has been performing worse-than-expected in the past few months. Google says it’s because they’ve reduced the number of “false positives” that advertisers were paying for, and that the changes they made help advertisers obtain more quality clicks.

First off, I don’t buy that this is the reason for the decline. Sure, it might have exacerbated it, but what about the fact that FireFox is gaining in popularity, and they have a plugin that blocks the javascript that Google Adsense uses? That is certainly playing a role, and that role will only get bigger. Not only that, but many companies are seeking to circumvent Google altogether, making deals with advertisers themselves. That’s exactly what we’re doing at Freund Investing.

Additionally, Google was, in the past, the only player in the advertising space. Many competitors have stepped up to the plate and are looking to get a slice of the large advertising pie, decreasing Google’s market share for those who haven’t ventured out into the advertising realm on their own.

Lastly, and perhaps most importantly, many businesses throughout the United States are facing reduced sales and, consequently, reduced advertising budgets. This will affect Google’s total revenue both in Q1 and for the remainder of 2008.

With a price-to-earnings ratio of 33.5, a serious earnings miss will be punished severely. It is not our belief that Google will miss by a large amount, but it is certainly not out of the realm of possibility. If Google does, by some miracle, surpass expectations, that might be a good opportunity to start a short position.

In the interest of full disclosure, Ryan Freund does not own any positions in any of the companies mentioned in this article.

Comments

[misterdan]

Interesting thoughts but I can't help but sense a bias (not to mention a lot of wishful thinking). So your ad company deals directly with advertisers??? Well, the local bodega sells bread, and the local mom & pop bookstore sells books but I dont think A&P or Barnes & Noble are going to lose any sleep over it. Many competitors have stepped up to the plate on both sides.....and this has been met with.....mostly indifference at best and irrelevance at worst.

What I take from your article is a tendency to exaggerate small facts that support your position and trivialize huge facts that dont support your position. The increasing popularity of Firefox and their ability to disabling of javascript is not going to cause many sleepless nights at Google largely because the total impact this will have is less than negligible. Finally, Im curious as to how good results and bad results are both going to be good for a short position. "What goes up must come down" is not what I call sound financial advice.

You are certainly entitled to your opinion but I would caution readers that this is strictly opinion with very little hard fact to back them up. Sorry, but I'm not drinking your Kool-ade but I do wish you the best with your Google-free advertising company!

[freakyguy666]

I agree with the comments above. I would also add that the blogger doesn't mention any of the recent positives: a) the increased market share in March, b) the fact that nearly 50% of their revenues come from international business, which by most accounts is growing much faster than US, and c) the protracted Yahoo/MSFT/AOL deal just gives Google that much more stability in the eyes of advertisers, not to mention the fact that these types of acquisitions take a loooong time to finalize and will be a distraction for the companies' management and likely allow Google to take advantage.

With regard to the stock price, it should be noted that the current Estimates have been slashed significantly and GOOG is STILL trading at a forward P/E of 18.5 with a 30% growth rate. Not too much downside unless you think Google management is just plain stupid. Not a good bet, imo.

[globalmacro]

The market is already pricing in a tough quarter. The stock market is a discounting mechanism. Some basic understanding of the market should be required before an article is written on seekingalpha.

[Ryan]

Misterdan, my company is not taking advertising away from Google. I do not compete with them at all. In fact, I use their service. That's my point. The ad revenue generated from AdSense is pathetic and many other options exist for generating better advertising revenue.

Freakyguy666, online marketing technology is a rapidly growing space with many competitors lining up to take a piece of the pie. Many many options are available to website owners (such as me) and Google is rapidly becoming a second choice play. Furthermore, a forward P/E means nothing, as does the 30% growth rate. Both of those are guesses, and analysts themselves say that it's nearly impossible to know what Google will report. Basing advice on that is not a good bet.

Globalmacro, while its true the market is pricing in a tough quarter, I'm simply saying I think it will be worse than expected, hence worse than what is priced in.

I am merely stating my observations, both as a Google customer and as a value investor. Take it with a grain of salt and do your own DD.

[degu77]

To the author,

you're quite wrong. I run my own website and rely on Google's adsense. What I do know is that Google's statements are not BS. They are indeed improving the quality of clicks from my experience. And I don't know how much more reliable a source can be if you're actually using their program. You are obviously just throwing around assumptions without anything to back it up. I don't care if you believe me or not but that's what I'm seeing for my website.

In addition, on the flip side, I tested it out and you can too. Have your buddies or whoever click on your ads even sparsely as once a day and Adsense will know that it's a phony false positive after the first unique click from that IP. Their software, from what I observe, is continuously being modified to weed out these false clicks. I have been using Adsense for over almost 18 months now and the click quality is always being improved.

Once again, you can try it out for yourself.

[Ryan]

Degu,

I also rely on adsense. I understand that many individuals and businesses rely on adsense. What I'm seeing, though, is an exodus to other advertising venues. Time will prove me right.

As for reducing false positives - I know they're succeeding at doing that, but that certainly isn't the only reason behind their reduced paid clicks. Something like 28% growth in Q4, now we just learned it's 2% growth in Q1 08? That's horrendous. And it's not just the reduction in false positives.

I don't have any vested interest in Google. I call it like I see it, and we will see what happens.

Good luck to everyone.

[degu77]

Ryan,

I have one final question though. You don't think it's odd how the growth can suddenly drop from 28% to 2%. I don't think that Google's management will make false claims to keep up their reputation. I think their click quality improvement program highly contributes to the dramatic decrease. But on the flip side, there will be more revenue per click to compensate quantity. So it's quality over quantity and I believe that the numbers will show it on Thursday.

If you think that internet users all of a sudden decided to stop clicking, I think that's unreasonable.

[Ryan Freund]

Degu,

No, I don't think internet users will stop clicking. I think those who have advertisements on their site are seeking other, more profitible ways of getting ad revenue. Google pays so very little. I also think the FireFox plugin that blocks Javascript (how adsense works) is hurting them.

Add to that the reduced advertising budgets of companies and you get a pretty dim picture of what's to come, at least in the next few quarters.

The 28% (or maybe it was 24%) drop down to 2% was not solely from reducing poor quality clicks. I have personally contributed to that reduction (I'm using AdSense less and less) and that has nothing to do with the quality of the clicks and everything to do with the revenue generated.

[globalmacro]

The market has been pricing in a disastrous quarter. There are no disasters at Google currently. I guess we'll know tomorrow.

[misterdan]

Regarding your Tuesday post. It would appear that your contrarian point of view was a whiff (i.e. swing and a miss). I give you credit for at least taking a position that went against the common thought but this time the "experts" pretty much called it right down the line. Up over 8 today and edged up slightly after hours. You do accurately point out some potential bumps in the road (though I would call them pebbles more than bumps) but you need to look at the really big picture. Google has so much untapped potential that it is almost mind-boggling. I like Firefox and use it from time to time but the overwhelming majority of users do not. Catching a few crumbs from Google is not going to threaten it and unless Firefox becomes widely accepted as the new IE (which is about as likely as Hillary Clinton deciding to run as V-P with John McCain) the net effect will be negligeable. Can you provide some evidence that Firefox is "hurting" Google? To me it's like saying that you are going to hurt a wild elephant with a pea-shooter.

[globalmacro]

I hope you were short. As I said, some basic understanding of the markets should be required before writing an article on seeking alpha.

[Ryan]

Global, as I've said many times now, I have no stake in Google, short or otherwise. Seeking Alpha is a place where people share their views, deal with it.

[degu77]

To the author Ryan,

I will cash in on over $100k tomorrow on good due diligence. Your research techniques and analysis are very poor. You were quite wrong. Enjoy sitting on the sidelines, cha ching!!

Bye bye Ryan, lol... what a terrible prediction by you. People just don't stop clicking genius.

[Ryan]

I never said people are stopping clicking. I said that competition is heating up and the money made with AdSense is pathetic. This is what I'm seeing: biz.yahoo.com/ap/08041...

I just moved 1/4 of my advertisements to a different ad network, from Google. I maintain that Google will face increased pressure and is too richly valued at $510 (or even $450). My opinion, but then again I often disagree with Wall Street.

Degu, congrats on the $100k.

[Ryan]

Wrong link... will find the one I meant to link.

[Ryan]

Oops, it was in the Wall Street Journal today. If you can get your hands on one...

[globalmacro]

Well at least you seem like a nice guy. I won't fault you for this one.

[globalmacro]

I have 631k in Google as of the open this morning. So, I do have a stake. I will say that its usually best to ask for advice on a stock or company from the people who have a real vested interest in the business.

[Ker]

You missed it Freund, but who doesnt make a mistake. Keep trying!