A new generation of dotcom punters on Friday discovered a financial fact of life: shares in Google can go down as well as up.
The 6% fall that greeted the search engine’s second- quarter earnings was hardly a rout, but was still a broad hint from Wall Street that Google requires perfection every time to maintain the sky-high rating on its shares.
At $300, having run up from last year’s flotation price of $85, the company is worth about $84-billion. Its revenues — that is, its turnover, not its profits — are likely to be $5,6-billion in 2005, so Google is being valued at about 15 times its annual sales, a valuation that is madness on any traditional investment measure.
The argument from Google’s fans is that traditional yardsticks should be abandoned when dealing with a revolutionary entity. Hasn’t Google invented a new business model? Won’t it double its revenues this year? Doesn’t it achieve operating margins that old-media dinosaurs like newspapers and TV broadcasters would die for?
Well, yes, yes, and yes, but the second-quarter figures also suggested that this revolutionary is not wholly immune from normal business pressures.
Revenues in the second quarter of $1,4-billion were up 98% year on year, but only 10% higher than in the first quarter. Quarterly sales growth of 10% is impressive, but when you’re expected to double annually, investors are entitled to fret.
Worse, Google itself hardly talked up its prospects for the current trading period. ”I would like to emphasise that Q3 is historically a slower quarter for growth in both advertising expenditures and internet usage,” said chief executive Eric Schmidt. So now we know: mundane seasonality even affects businesses that have changed the way the western world operates.
But it was the slip in profit margins that was most significant. The first quarter saw 35,2% and the second 34,4%. That’s not a collapse, but outsiders will wonder whether we have seen the top.
The issue of margins is the real long-term worry about Google. It is comparatively easy to accept that the business might double its sales annually for a while yet, but harder to believe it can continue to convert over a third of its turnover into profit.
Google is ultimately in the game of selling advertising space. Demand for such space is currently booming as corporates appreciate the power of the internet to shift goods, but Google is not operating in a vacuum. Yahoo!, Microsoft and others are competing for the same pie.
Competition from a range of well-funded and technically innovative companies suggests that returns on capital in this business will eventually settle down, just as they do in most industries.
We won’t know where precisely they settle for several years, which is why investing in Google will continue to be an act of faith. Prudential, the big US brokerage, yesterday declared Google’s latest quarter ”extremely impressive” and set a target of $400 for the share price.
Googlemania clearly is not over yet. But, in time, July 2005 may come to be seen as the moment when investors in this impressive company were warned that no share is a one-way bet for ever. – Guardian Unlimited Â