I was expecting good 3Q10 earnings from Google but I thought it would be built on better cost controls. 2Q10 results that led to a big slide in the shares saw higher investment spending overwhelm a small top line beat. Ahead of the 3Q numbers, I expected another quarter of revenue strength but figured management had gotten the message and would keep a lid on expense growth.
Google did produce a strong quarter and significant positive surprise but it was built mostly on better than expected revenue. Search came in a little higher than expected, providing relief against the onslaught from Bing and competitive worries in mobile and from apps. Display and mobile both exceeded expectations, growing 30% and 60%, respectively. More importantly to investors, management provided specific revenue run rates and optimistic commentary for these emerging businesses. Display and mobile now make up about 15% of Google’s revenue and their fast growth should represent more than 25% of future growth. With these businesses now sized and contributing, higher expenses to support their growth are deemed acceptable by Wall Street.
The bottom line is that Google’s numbers revived the growth story. In addition, Google reminded investors it can still produce upside surprises. The stock is not expensive for a company still growing more than 20% annually. Earnings in 2011 could approach $35 and 2012 should be over $40. Back out the massive cash reserves on the balance sheet and the stock trades around 15 times forward earnings. This is a reasonable, arguably compelling, valuation for a fast growing leader in one of a few global growth industries, especially with Google shares still down 5% in 2010 after the 9% pop off today.
Disclosure: Google is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, an SEC registered, long only investment advisor. Google is a new long position in the Entermedia Funds. Steve Birenberg is co-portfolio manager of the Funds, owns a stake in Entermedia’s investment management company, and has personal monies invested in the Funds.