Google Earnings Beat Estimates—Again

The search megalith reported stellar third-quarter earnings, though it warned that margins may thin as it makes needed investments
The Google stand at the Frankfurt Book Fair, Oct. 10, 2007 Getty Images

As a company that regularly beats Wall Street's earnings estimates, Google needed to blow away expectations on Oct. 18 to impress investors who have propelled the stock to record highs in recent days in anticipation of yet another blockbuster quarterly announcement. Anything less and investors would sell off the stock as they had in past quarters when Google just met or narrowly exceeded analysts' projections.

Google (GOOG) did not disappoint. The search-advertising Goliath said third-quarter net revenue rose 61%, to $3.01 billion, a number that takes into account the amount Google pays Web site owners to put ads on their pages. That soundly beat analysts' average estimate for sales of $2.9 billion. Not counting the amount of stock awarded to employees, earnings per share rose to $3.91, beating forecasts of $3.78 a share. "We had a very strong quarter across the board," said Chief Financial Officer George Reyes.

Online Ad Dominance Assured

Wall Street assumed that Google's revenues, minus traffic-acquisition costs, would grow about 57% from the prior year. They also assumed that Google could hit that number despite an anticipated credit-crunch-related slowdown in financial-services advertising, one of the largest Web marketing categories. "When you have a company that has performed as consistently as they have to the upside, there is an inherent expectation that gets built into performance," says Derek Brown, an Internet analyst at Cantor Fitzgerald. "They are larger, growing faster, and are more profitable than any company in the Internet sector by a wide margin."

Google owes its growth mainly to its dominant share of the online advertising market. Google captures roughly 32% of the $21.4 billion in U.S. advertising spending, according to an Oct. 16 report by research firm eMarketer. Google is especially adept at search advertising, which comprises more than 40% of the U.S. online advertising market.

Now Google is racing to gain a larger slice of other forms of online advertising, including display advertising, the term given to ads that run in a fixed spot on a Web page. That's why Google agreed to acquire ad network DoubleClick for $3.1 billion (, 9/28/07) earlier this year.

New Ad Forays Won't Come Cheap

Google is also taking steps to get into video advertising, a segment that eMarketer estimates could comprise more than 13% of the online advertising market in four years, up from 8.2% this year. In August, Google announced plans to embed ads in YouTube videos. "We have a really nice ad that shows up in the bottom half of the video," Google co-founder Sergey Brin said during the analyst call.

Google's forays into other advertising arenas are still early, and its success is by no means guaranteed. A deal that lets Google place ads on News Corp.'s (NWS) social network, MySpace, is going well, according to Google, but it's still not a resounding success. "It is obviously a challenge because there is so much inventory and people can be distracted by many different things," Google co-founder Larry Page said on the conference call. "So there are a lot of things that make it hard."

One thing that makes it difficult to carve a slice of new areas of advertising is the cost. Google executives have pledged that they will continue to spend money on the infrastructure improvements and the personnel necessary to innovate around new ad formats. During the earnings call, CFO Reyes cautioned analysts that such investment could take a toll. "Margins may decline as we continue to invest in our business," said Reyes.

Analysts Worry About Spending

Despite the blockbuster quarter, analysts expressed some concern that Google may be investing too much, too quickly. During the call, several analysts posed pointed questions about Google's decision to hire an additional 2,100 employees during the quarter. Google blamed a less-than-amazing performance last July in part on hiring more aggressively than it had initially planned (, 7/20/07). Chief Executive Eric Schmidt tried to allay concerns, saying, "this is an area where we need to spend more time and focus on what is the appropriate rate…We are paying a lot of attention to head count."

But for now, it's hard for even cautious analysts to be negative about Google's numbers.

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