Google last week proposed a new way of looking at things, a special kind of glasses, called "Project Glass," that it says will project Internet search results right on your eyeballs. It was a hilarious proposal given that Google's stock is what investors need a new way of seeing.
Google (ticker: GOOG) shares are down 2% this year at last Thursday's close of $632.32, trailing the 18% surge in the Nasdaq Composite Index. The stock has merely kept pace with the index the past 12 months. That's despite having increased revenue nearly 30% in 2012 and boosting profit more than 20%.
The stock fetches just under 15 times this year's projected $42.50 a share, or 11.7 times when one factors in the nearly $140 a share in cash and equivalents and investments the company had on its balance sheet at the end of last quarter.
So why isn't the stock working?
Sure, Google suffers just like Apple (AAPL), which fetches a similar P/E, related to the broad depression in tech-stock valuations. But what's different about Google is that it communicates far less effectively with investors than Apple or other peers. Not only won't management discuss the future, but they tend to do a remarkably sloppy job of even talking about the recent past.
I'll come back to that in a moment. Suffice it to say that for lack of communication, in the breach, investors find all kinds of things to worry about.
First is declining profitability. When Google reported fourth-quarter results in January, it said that its volume of "paid clicks," the number of times people clicked on search results for which Google was paid by advertisers, rose 34%. But the "cost-per-click," the average it gets paid, was down 8%.
It was the first year-over-year drop since Q3 of 2009. The first drop since the recession, in other words.
Part of that, ironically, was a result of Google's improving its search results. As it weeded out less-relevant results, the auctions through which it sells ads actually became more efficient, lowering rates, explains Ron Josey, who follows the stock for boutique brokerage ThinkEquity.
Another factor was mobile advertising, which is becoming a bigger part of search but currently brings a lower CPC. Josey, who rates Google shares a Buy, thinks the self-inflicted harm of search improvements will abate in coming quarters as paid clicks continue to rise. He also thinks mobile ad rates will tick up over time. He models Google's CPC returning to positive year-over-year growth in the fourth quarter of this year.
Second, Europe, where Google has an estimated 85% of the search market, even more than in the U.S., is at risk of deteriorating. Results there were "actually quite healthy" in the fourth quarter, Google said. But it did note that revenue growth in Germany slowed.
That was enough to make Europe the biggest problem for the stock these days, in the opinion of Clay Moran of Benchmark Co., who has a Hold rating on the shares. Moran argues that should Google see real deterioration in Europe, there are limited ways to offset it, given that Europe makes up 35% to 40% of annual revenue. In his view, it will simply take time for economic malaise in Europe to abate and for the "earnings and the momentum of earnings to come back into focus," which he thinks they will at some point.
Third, Google is paying $12.5 billion to acquire smartphone maker Motorola Mobility (MMI). Investors didn't like the sheer size of the cash outlay, but they also worry that it has caused unease among the partners that use Google's Android software and now view it as a competitor.
Moreover, Moto is projected to have just a 1.6% operating profit margin in 2013, before interest and taxes, according to Brian Nowak, who follows Google for Nomura Equity Research. That's far below what he estimates as a 37% margin for Google. Combined, the two entities will result in a 6.5-percentage-point drop in Google's pretax margin.
Nowak is not overly concerned, given that Google has promised to report results for each side of the combined company, which may allay some investor anxiety.
Fourth, investors worry Facebook is set to take share from Google in the advertising business. With Facebook preparing a public offering, the increased competition could also steal investor dollars from Google's stock. Perhaps, says Nowak. But if Facebook is poised to take away ad dollars, it doesn't seem to be showing up in the data so far.
Facebook is where people look at photos and post missives, not where they search, per se.
Fifth and last, Google has been the subject of numerous inquiries regarding its market dominance and the risk of its encroachment on privacy on the Web. The threat of regulation is a very real concern. But investors are probably overestimating the risk to Google of government initiatives, argues Carlos Kirjner of Bernstein Research, who observes that Google is currently already operating under a consent decree, related to its use of users' private data, forced upon it last year by the Federal Trade Commission.
Anything that would come out of current regulatory investigations or privacy legislation, here or abroad, actually looks less onerous than what was in that FTC decree, Kirjner tells me.
All those arguments are debatable, which brings us back to communication—and what everyone, bull and bear alike, agrees upon, is that Google does a poor job of it. Notice that in the year since Larry Page became CEO, Google's stock has merely treaded water, even though there have actually been positive data points. In the fourth quarter, for instance, Google announced its "display" advertising business, as opposed to its search ads, was on course to make $5 billion in sales annually. That's more than roughly double the run rate projected in the third quarter of 2010.
This little tidbit, which is important, is the kind of data that Google doles out in laissez-faire fashion—"as we feel like it," if you will. In a lengthy letter from CEO Page last week on Google's blog, he waxed euphoric, philosophically, about opportunities. But there was nothing of the kind of concrete, direct reflection on operating results that investors would like to hear more of.
If Google is going to promote wild R&D dreams like Google Glass, it had better get in touch with some of the more prosaic details of management, such as talking with investors.
iTry
Microsoft will launch its latest smartphone challenge to Apple and Google. The Nasdaq Composite Index ended Thursday at 3,080.50—down 0.36% over four days.
Tiernan Ray can be reached at tiernan.ray@barrons.com or at blogs.barrons.com/techtraderdaily or www.twitter.com/barronstechblog.
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