What Do Yahoo’s Earnings Mean for Google?

Ad revenue is down -- but all is not lost for the search king

   
What Do Yahoo’s Earnings Mean for Google?

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stockoftheweek What Do Yahoos Earnings Mean for Google?Yahoo’s (NASDAQ:YHOO) mediocre earnings report does not bode well for Google (NASDAQ:GOOG), which reports earnings later today.

Though Google is best known as the leading search engine, display advertising is becoming increasingly important to the Mountain View, Calif., company as its core business becomes increasingly squeezed by rivals.

Google’s display business, which includes network ads and YouTube, generated about $5 billion in annual revenue in 2012, double from the $2.5 billion it earned in 2010. Based on current trends, the business should post gains in 2013 as well.

eMarketer estimates that Google’s share of the display market will rise to 18% this year, edging out Facebook (NASDAQ:FB), which will hit 16%. Yahoo, for its part, will see its portion of the market slip to 7.7% from 9%, the researcher said. That trend was evident in the company’s most recent quarter.

Yahoo’s display revenue fell 11% to $455 million in the latest quarter, which was worse than what analysts had expected (which wasn’t all that much). Yahoo CEO Marissa Mayer could make life tough for her former bosses at Google by keeping advertising rates low. That could also hurt other web publishers such as AOL (NYSE:AOL), which is in the midst of a surprising turnaround under CEO Tim Armstrong.

Yahoo’s search business continues to languish as well. Search revenue excluding fees Yahoo paid to its partners plunged 10% to $425 million. Yahoo’s search partnership with Microsoft (NASDAQ:MSFT) is underperforming, according to Yahoo. To make matters worse, Microsoft’s Bing.com is gaining share at Yahoo’s expense. This raises the question of whether Yahoo will invest more in search to address this trend, or throw in the towel and cede the business to Google.

Though Google remains the undisputed king of search, the value of its kingdom is eroding. During the fourth quarter, the average cost per click — the fees that Google charges advertisers for ads served on Google sites and its network — fell 4% on a year-over year basis. Soft pricing for search hurt Yahoo in the just-reported quarter and no doubt affected Google as well.

The trends in the mobile advertising sector are just as depressing for Google. As IDC recently noted, mobile publishers such as Twitter, Facebook and Pandora (NYSE:P) are “rapidly taking over the mobile display advertising market in the United States.” Google and rivals such as Apple (NASDAQ:AAPL) no longer control the segment, the market researcher says.

Shares of Google have gained 10.6% this year, underperforming those of Yahoo, which have surged more than 19%. Yahoo’s outperformance is attributable to the rock-star status investors have given new CEO Marissa Mayer. She is young and full of ideas on how to bring Yahoo back to its former glory. Unfortunately, shaking away the mismanagement of the past decade or so isn’t going to be easy — and investor sentiment can turn on her in an instant.

Google has the opposite problem. For most of its history, the search engine giant could do no wrong. And expectations are subsequently high for the current quarter. Net income is expected to surge 23% to $3.5 billion, or $10.69 a share. Revenue is expected to surge 31% to $14 billion. Though Google’s Android operating system powers nearly three-quarters of the world’s smartphones, the company still earns most of its profits from advertising … and therein lies the problem. As digital advertising takes an ever-larger part of overall spending, its growth rates are expected to slow. The ramifications of this trend will be felt for years to come.

Many on Wall Street still have faith in Google. The average 52-week price target on the shares is $879.94. Its trailing price-to-earnings multiple of around 24 is near a five-year low. Despite its challenges, the stock is worth investors adding to investors’ portfolios provided that they have a high tolerance for risk and an iron constitution.

At the time of publication, Jonathan Berr did not own shares of the aforementioned stocks.

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