End Of The Road For Google?

End Of The Road For Google?

Since its IPO in August 2004 Google (GOOG) has long been a market darling, continually beating market estimates and providing investors with stellar returns. It was priced for perfection, trading at triple digit multiples, with the future being seen as nothing but bright. It was this perfection that set the company up for a large fall if it could not meet these lofty expectations. Well January 31, 2006 was the day that Google did not perform to perfection, at least in the eyes of investors, who sent the price of shares down nearly 12% in after-hours trading. Let's take a look at Google's fourth quarter results to get an idea of how bad the miss was.

Google reported earnings of $1.54 per share on a non-GAAP basis compared to market expectations of $1.76 per share. The company reported GAAP net income of $1.22 but eliminated charges that arouse from stock-based compensation, a charitable donation, and a charge from in-process research and development to arrive at the $1.54 reported EPS number. This was the first time that Google missed expectations since the company went public.

The company blamed an unexpected hike in their effective tax rate, which rose from 30% to 41.6%, as the main cause of the earnings miss. The rate increase stemmed from an unexpectedly large international expense which allocated more income to the U.S. side of the business, one which faces a higher tax rate. The company expects that the overall tax rate for 2006 to be 30%.

If you forget the tax rate increase the performance at Google remained relatively strong as revenues at the company grew 86% to $1.919B in the fourth quarter compared to $1.032B in the same quarter in 2004. GAAP net income for the quarter was $372M which was an increase of 82% compared to net income of $204M in the fourth quarter of 2004. However there are signs of a slow down in growth, proving that Google can't avoid the restrictions of the growth curve (sort of like avoiding the laws of gravity). Revenue grew 22% from Q3 to Q4 in 2005, lower than the 28% growth achieved between Q3 and Q4 in 2004.

So is the party over at Google? Is it time to sell? These are highly contested issues, where there exists two well defined camps, Google bears and Google bulls. However, I am going to set up shop on the sidelines for now. The reason for this is I like the future of Google's business and the internet ad space but I do not feel as strongly about the valuations the company currently sports and the return potential.

While the valuations of the company are relatively high and it is futile to predict short-term price movements, I will not be shorting shares in Google anytime soon however. The reason for this is that the company remains the best online search tool in the market making it attractive to advertisers who are increasingly embracing online advertising, seemingly recognizing that it is an inevitable evolutionary step. Revenue and income growth while expected to slow over time continues to grow at rapid rates, which will likely provide the company will healthy growth for the foreseeable future. The company continues to add features that both attract additional viewers and add new revenue streams. One such feature is the addition of searchable content which allows users to download TV broadcasts for a small fee. For example you can go to Google Video and download the entire LA Lakers game in which Kobe scored 81 points for $3.95.

There is no question that this was a disappointing quarter for investors but in my opinion it is not an end of the world quarter. The company remains strong and so does its growth potential for the future. The fact is however, much of this supersized future growth is already priced into the shares, leaving investors with little, if any, margin of safety. The lack of margin of safety will likely lead to a lot more volatility in GOOG shares.

This is not the end of the road for Google but it may be the start of a lot bumpier one.

Source: Misc. Online Contents

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Sumit K. Gupta
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