Google Shares Fall after Profit Disappoints

By Dan Gallagher (July 27, 2007)

Analysts responded by rallying around the Internet search giant, calling the weakness a buying opportunity for a stock that has already jumped about 50% in the last 12 months.

Late Wednesday, Google (GOOG) reported a 28% gain in earnings for the June quarter. Revenue jumped 57% from the same period last year as the company continued to dominate the online advertising space.

However, Google's massive hiring caused a jump in expenses related to payroll and bonuses beyond what the company had budgeted.

That caused earnings per share to come in below analysts predictions, even though revenue exceeded estimates.

Shares of Google slumped by $28.47 to close at $520.12 on Friday - essentially giving up gains made by the stock over the last month. The stock hit a record high of $558.58 on Monday.

Wall Street Rallies

Wall Street was already highly bullish on the stock. Out of 38 analysts covering Google, only three rate the shares as neutral while none carry sell ratings, according to data from Thomson Financial.
 
In most reports Friday, analysts dismissed the earnings miss as the result of the company investing in future growth - not a cause of concern about its fundamental business.

"We feel any pullback - due to an unexpected rate of investment in growth and personnel causing a soft 2Q07 bottom-line - as an excellent buying opportunity for an attractively valued long-term sector winner," Stewart Barry of ThinkEquity wrote in a note to clients Friday morning.

Barry maintained his $700 price target on the shares - the highest among Wall Street analysts covering Google.

Ben Schachter of UBS also maintained his buy rating and $665 price target on the stock, but noted that the earnings miss has likely tempered expectations and will keep the shares "range bound" for a while.

"While true long-term bulls will view this as a buying opportunity, we believe that most 'fast-money' will leave the story, at least through the end of the summer," he wrote.

A more cautious note was sounded by Leland Westerfield of BMO Capital Markets, who is one of the few analysts carrying a neutral rating on Google.

In his report, he said a greater concern than the earnings miss is the "labor cost inflation" shown by the high payroll expenses and the low "cost-per-click" growth rate that indicates how effectively the company turns Internet searches into revenue.

"That slow CPC growth might be explained by international territorial expansion (temporary, not a worry) or by slowing productivity gains in monetization (secular, a worry)," Westerfield wrote.

Earnings Grow

After Thursday's closing bell, the Mountain View, Calif., company posted earnings of $925.1 million, or $2.93 a share, compared with $721.1 million, or $2.33, in the year-earlier period.

Excluding the impact of stock options and other charges, the company earned $1.12 billion, or $3.56 a share.
Wall Street had been expecting the company to earn $3.59 a share, according to Thomson First Call.

Revenue surged to $3.87 billion from $2.46 billion. The company said it paid $1.15 billion in traffic acquisition costs for the quarter, leaving it with net revenue of $2.72 billion. That beat the $2.68 billion expected by analysts.

The company said cash and equivalents grew to $4.5 billion at the end of the quarter from $3.5 billion at the end of December.

Rising Costs

Expenses grew in every category. Research and development expenses totaled 13% of revenue for the quarter compared with 11.5% last year. General and administrative expenses grew to 8.2% of revenue compared with 7% last year.

In the conference call, CEO Eric Schmidt said that one area the company exceeded its expense plan was in hiring, which added more than 1,500 workers to the payroll during the quarter.

"We are very pleased with the talent that we've brought on board, but going forward we will watch this area very closely," he said.

The company also adjusted its accounting for its employee bonus plan. Chief Financial Officer George Reyes said the change "will allow us to more proportionately recognize the related expenses each quarter" but led to a higher bonus accrual in the second quarter.

Still, the company was able to expand its margins as well. Operating income in the period was 33% of sales compared with 28.5% a year earlier.

The company has continued to use its dominant position in the online search market to reap increasing amounts of related advertising revenue at the expense of chief rival Yahoo.

According to data last week from Compete Inc., Google maintained its large lead in the online search market from May to June, gaining 0.3% to a 62.7% share. That compares to a 19.6% share for second-place Yahoo (YHOO) and a 13.2% share for Microsoft Corp.

Dan Gallagher is MarketWatch's technology editor, based in San Francisco.

Originally appeared in MarketWatch.