Pressure Is on Google as Earnings Near

Google's results will provide a glimpse at the health of the world's largest Internet search firm, and the broader online advertising market

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Chris Helgren / REUTERS

A Google logo is seen at the entrance to the company's offices in Toronto .

Update Oct 17th 7 p.m. EDT: Google reported better than expected financial results after the market closed Thursday, sending the company’s stock soaring to a new record high. Story here.

In the years immediately following Google‘s 2004 initial public offering, the Internet search giant saw explosive growth, with revenue nearly doubling every year. But lately, as Google has become a mature company, the company’s growth rate has slowed. It now hovers around 20% on an annual basis. On Thursday, Google will report its latest quarterly earnings results, and Wall Street will be watching closely to see if the search giant can rebound from a disappointing performance in July. As usual, Google’s results will be an important signal about the health of the broader online advertising market.

Overall, Google has had a solid 2013 on Wall Street; its stock price has increased by 24% since the beginning of the year. (By contrast, the company’s rival, Apple, has seen its stock decline by nearly 10% so far this year.) In its most important and profitable business, Internet search advertising, Google continues to dominate, with 66.9% of the total market share in August 2013, followed by Microsoft with 17.9% share, according to market research firm comScore. Yahoo continues to lose search market share and accounted for 11.4% of searches in August.

For Colin W. Gillis, a technology analyst at BGC, one of the key questions for Google is whether revenue from company-owned websites can accelerate back to growth that exceeds 20%. Gillis points out the Google has posted four consecutive quarters of growth below 20% in its core business, a substantial deceleration from the 35% annual growth that the company delivered as recently as 2011. Gillis estimates that Google will deliver revenue of $9.23 billion from company-owned sites, which would be a 19.5% increase from last year. “We see the slowing core business as a one reason why Google is investing so heavily in new ventures as new products are needed to reignite revenue growth,” says Gillis.

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Last quarter, Google reported overall revenue of $14.11 billion, an increase of 19.5% compared to the previous year, but those results fell short of the $14.42 billion that analysts were expecting. The search giant reported earnings-per-share of $9.56, well below the $10.78 per share that analysts had been looking for. Those results sent the company’s stock price tumbling, but most Wall Street analysts agreed that there’s nothing fundamentally wrong with the company. Because Google doesn’t give earnings guidance, it can be difficult to predict the company’s financial performance, and one stumble can rattle investors, as occured last quarter.

Ben Schachter, a technology analyst at Macquarie Research, cited the difficulty in modeling Google’s financial performance as his number one risk for the stock. “Sentiment is relatively weak on the quarter, as investor expectations remain subdued,” Schachter wrote in a note to clients. “While we are broadly positive on the core businesses, with the complexity of the model, we have little confidence in our or the Street’s collective ability to estimate quarterly numbers. While visibility has always been limited, the expansion of businesses and the limited disclosure have increased the model complexity significantly.”

One area that Wall Street analysts will be focused on is Google’s display advertising performance. Unlike in the traditional search ad market, the company faces robust competition from the likes of Facebook, Yahoo, Microsoft, and AOL. “We are broadly positive on display, particularly for YouTube,” Schachter wrote. “However, we believe that Facebook is gaining ad dollar share at the expense of traditional online display players, including the Google Display Network.”

Another area of intense Wall Street interest is Google’s “cost per click,” which is the price marketers pay to advertise on the company’s platform. As users shift from desktop computing to mobile computing, Google’s cost per click has declined, because marketers tend to pay less for ads on the company’s mobile search platform, compared to its desktop search platform. Last quarter, Google’s cost per click declined 6%, double the 3% decline that analysts had been expecting. That said, Google has an enormous opportunity in the mobile advertising market, which remains in infancy. Google is well positioned here, because the company’s Android mobile operating system is the world’s top mobile platform.

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As usual, Wall Street investors will be looking for an update on the company’s far-flung initiatives beyond its core Internet advertising business. These projects include Google Glass, the company’s highly touted computerized eyewear, and the self-driving cars program, both of which come out of the secretive Google X lab, which is run by co-founder Sergey Brin. Investors have occasionally expressed concern that these products could divert focus and resources away from the company’s core business, and put pressure on its profit margins.

Schachter noted that Google’s profit margins “could come under pressure” as the company continues to invest in “interesting (and potentially lucrative) non-core projects,” such as Google Fiber, the company’s high-speed Internet access project, self-driving cars, Chrome hardware, enterprise products, and other initiatives. “These projects represent longer-term opportunities for Google,” Schachter wrote. On a related note, analysts will be interested to see how Google is managing expenses. Gillis points out that last quarter, Google’s expenses grew more than 26% from last year, compared to revenue growth of 19.5%.

In general, Google continues to perform very well, which is no small achievement in a technology industry evolving at break-neck speed. Technology is hard work, and complacency, product misfires, or strategic confusion can have severe consequences. One need only look at what’s happened over the last few years to BlackBerry, Yahoo, Hewlett-Packard and Microsoft to see how the once-mighty can fall. Few companies can maintain the kind of growth that Google enjoyed during the years following its IPO, and as Google has matured, expectations have tempered. Thursday’s results will provide an important glimpse into the health of the world’s largest Internet search firm, and the broader state of the online advertising market.