What’s Unexplained in Google’s Earnings Flop

Now that Google (NASDAQ:GOOG) has posted revenue and earnings that were well short of the Street’s expectations, the question is: How bad is it?

On the face of it, it looks bad indeed. Google’s stock tumbled as much as 10% to $574 in afterhours trading Thursday, after the company posted revenue of $8.13 billion in the fourth quarter of 2011 and earnings $9.50 per share. That was shy of the $8.41 billion and $10.49 per share that analysts had been expecting.

Later on, the stock recovered to $582, suggesting things might not be as dark as the headline numbers suggest. But the truth is it will take a little time to know exactly how bad these numbers were, since Google didn’t give much insight into why it happened.

Some of the reasons for the lower-than-expected profit may not signal a slowing business. Interest and other income was a negative $18 million, against a positive $302 million in the previous quarter, which may reflect currency-related losses. And Google’s tax rate was 22%, higher than some analysts were expecting.

But the biggest factor seemed to be unspecified changes in Google’s advertising format, which significantly reduced its cost-per-click rates — the dollars that Google receives whenever a user clicks through one of the sponsored ads on its sites. Cost-per-click, which rose 5% in the third quarter, dropped 8% in the fourth, while many analysts were expecting it to increase.

Google’s explanation of the changes in ad formats was frustratingly vague. The company routinely tweaks its ad formats, often to discourage ad-word manipulation, with different results in clicks. A recent change resulted in increased clicks at lower cost-per-click rates, which somehow added to revenue in the third quarter but hurt it in the fourth.

If you can decipher that explanation, you might have a job waiting for you in Google’s accounting department.

The question is important, however, because Google is making aggressive changes in its search-result pages and other features as it builds a social-networking element into its products. Ad rates could be declining as more advertisers turn to Facebook. Or because Google+ is pulling eyeballs away from the search pages where sponsored links are more often clicked on.

But such theories are just speculation until Google gives more clarity for the slower growth. Revenue grew at a 25% annual rate, which certainly isn’t bad in this weak global economy. But on the other hand, it’s well below the 32% growth rate that the Street had been looking for.

Some clues may be found in other metrics. International revenue rose only 6%, suggesting the financial turmoil in Europe may have put a drag on Google’s total take. Revenue on Google’s own sites rose 29%, while that from affiliate sites rose only 15%, perhaps the result of users spending more time inside social networks like Facebook and less on Web pages hosting Google ads.

Encouragingly, Google’s margins held up. Operating margin for the fourth quarter was 33%, up from 31% in the previous quarter but down from 35% in the same quarter a year earlier. R&D costs fell to 12% from 14% in the previous quarter, reflecting the company’s push to eliminate noncore products.

Google is navigating the choppy waters of an ad market in an uncertain world economy. It could easily bounce back with changes in its ad formats and new revenue from mobile devices or Google+. But it could just as easily be seeing Facebook finally cut materially into its future growth. Only time will tell — because the company certainly isn’t.

Article printed from InvestorPlace Media, https://investorplace.com/2012/01/whats-unexplained-in-googles-earnings-flop/.

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