It’s hard to say whether Google’s 7% aftermarket plummet was the result of “higher expenses” (the popular story) or the stock just having been too high in the first place, but all the hand-wringing about an “earnings miss” is almost certainly an overreaction.
Google’s expenses were higher than expected because:
1) The company hired more people than it planned to, and
2) The company changed the way it accounts for bonuses, which required a “catch-up” accrual from the first quarter.
The second factor is a one-time item unrelated to the company’s performance (translation: It’s meaningless). The first factor, the “over-hiring,” could indicate a problem, but only if you believe Google’s management is shading the truth.
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 Google), or revenue comes in where the company thinks it will and they actually just…overspend.
Google’s revenue performance in the quarter was strong–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. CEO 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.
Google’s already enormous free cash flow, meanwhile, is continuing to grow again, after more than a year of stagnation while the company poured billions into data centres, 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 a price multiple of about 50X-55X free cash flow. This means the stock is still expensive. Not outrageous, but expensive.
The dissection of Google’s quarterly results, of course, always distracts everyone from the real story, which is simply not to be believed. Eight years ago, Google didn’t exist. Now, it’s generating $15-plus billion in annual revenue and $4 billion in profit, all from organic growth, and has more than 13,000 employees.
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