The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

24 July 2006

Google's Q2 2006

Ray Seakan writes,

"I was surprised that GOOG (the stock - not the company) did not react more positively to the earnings report. It looked pretty impressive from the reports on CNBC. Maybe something was hidden in there that they didn't reveal?"
To which I reply,
I view this reaction as a standard oscillation in price; i.e., a hoped for "high level (price) consolidation while the earnings explode upwards causing the PE to shrivel. Of course, at some point the law of large numbers will enter the picture. Many investors hesitate purchasing the stock pending the completion of this particular pattern.

But other people have their own opinions. The commentary below offers an example of just that.

-- David M Gordon / The Deipnosophist
Google Capital Spending Casts Shadow On Strong 2Q Results
Google/GOOG's second-quarter financial results affirmed the company is the most luminous of the Internet powerhouses.

The Web-search phenomenon is now larger in revenue terms than both Yahoo/YHOO and eBay/EBAY. Yet its revenue growth is three times faster and it exceeds both in operating profitability. That makes Google a truly “extraordinary company,” says Pacific Growth analyst Derek Brown.

Still, a nagging investor concern remains: the risk to profits from Google’s escalating expenses, as it rapidly builds out data centers, buys office space and scrambles to hire every genius it can find. So far results suggest Google’s aggressive approach to expansion and investment in growth initiatives is paying off. The company has sacrificed just 2 points of profit margin this year to produce more than 88% net revenue growth, notes Robert S. Peck of Bear Stearns. But investors will continue to watch its costs like hawks.

“The ultimate question mark on the investment thesis for Google is its capital spending,” Peck wrote in a note to clients Friday. “Is Google’s capex spending creating what will be the ultimate competitive advantage/barrier to entry to its hopeful competitors? Or is Google egregiously wasting capital, opening the door for competition?”

Google’s capital expenditures were $699 million in the second quarter, with real estate purchases accounting for $319 million and the rest mainly used for expanding data center and computing infrastructure needs. Excluding the real estate expenses, capital spending was 10% higher than in the first quarter and 140% higher than a year ago.

Total costs and expenses were $1.64 billion in the quarter, up 81% from a year ago. Google’s hiring spree continued unabated; the company had 7,942 employees as of June 30, up 1,152 from the first quarter.

The company promises even more spending, and on Thursday again warned investors that capital spending growth would “substantially” outpace revenue growth this year.

“Realistically, we think we can’t put too much capex into the system. It’s a really critical part of our competitive advantageand our infrastructure. And it’s something that you’re going to continue to see... over the next few quarters,” Chief Financial Officer George Reyes said on a conference call with analysts to discuss quarterly results.

He promised that Google “will continue to make strategic investments to allow us to maintain our leadership position in search and ads and to pursue additional growth opportunities.”

Pacific Growth doesn’t have a business relationship with Google, but Brown owns shares in the company. Bear Stearns has a business relationship with Google.

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