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Vinay Singh
Vinay Singh
Articles (229) 

Google Is Facing Some Serious Problems

May 17, 2014 | About:

Google (NASDAQ:GOOG) continues to see impressive top-line growth. That's the good news. The problem is that its core advertising business is seeing weakness as customers gravitate to mobile devices. That's led to a decrease in the amount Google gets paid for each ad it shows.

Top-line growth has been hiding the contraction in profit margins, but that can only last so long. For example, the company's profit margin has fallen from around 35% in 2010 to about 25% last year. That's a huge drop in two years.

Part of that drop stems from the purchase of Motorola Mobility, but increased use of mobile devices is the real issue to watch. According to Reuters, the amount that Google charges per ad slid 6% in the quarter. That comes on top of a 4% decline in the first quarter. The trend is going the wrong way.

That said, volume growth is basically making up for the shortfall. The company owns around 70% of the handset market with its ubiquitous Android operating system according to researcher IDC. As more and more customers get used to using mobile devices, it is in prime position to benefit. For example, The number of ads going through Google's system was up around 20% in each of the first two quarters.

Time to Bail?

Although Google is a great business, the shares are trading near all time highs. And despite the disappointment, the shares only ended down a percent or so the day after it released earnings despite gapping notably lower at the start of trading. Investors appear to be willing to afford Google the benefit of the doubt. That can only last so long. Investors should consider taking some profits or shifting completely to another option.

Facebook is a good choice for those seeking a notable Internet company that's something of a turnaround situation. The shares only recently began to trade above their IPO price, and earnings may be starting to pick up. For example, it made a penny a share in the fourth quarter of 2012, nine cents in the first quarter, and $0.13 in the second quarter.

The big shift here is mobile, too. Only Facebook has a loyal customer base that spends a lot of time using its service to keep up with friends and family. The company relies on advertising for around 85% of its revenues, with mobile ads making up an increasingly large portion of the total. And those ads are starting to sell better.

And the company continues to add customers, so, like Google, volume growth shouldn't be a problem. Although its price to earnings ratio is in the hundreds, suggesting that the stock is wildly overvalued by virtually any measure, the company is truly a turnaround in the making. There's notable upside potential for more aggressive investors if management can continue the momentum in its mobile shift.

A Value Stock?

Another option that investors might consider is Apple. Although Google's mobile market share dwarfs Apple's around 20% share, Apple's stock has fallen some 40% from its all-time highs. The PE is about 11. Unlike Google, which sports a PE of around 25, Apple almost appears to be a value stock.

Add to that a yield of around 2.8% and Apple shares are paying you relatively well to stick around. That, of course, is the issue. After posting astounding top- and bottom-line gains over the past decade, investors are concerned about Apple's ability to keep growing.

That's a legitimate concern. Although sales and earnings haven't fallen off yet, inventory buildups at suppliers suggest that tepid sales could be in the offing. What the company needs is to find a vast new customer base to tap or it has to convince customers to buy more products.

China and India are the obvious choices for new customers, but Apple has had a hard time breaking into both markets. And improvements in mobile devices haven't been enough to make customers upgrade until they actually have to. To be fair, that's an issue facing Samsung, too.

That said, Apple has a loyal customer base that has bought into its ecosystem. They will be loath to leave. And the company is trying to shift toward annuity-like services, including the recent iTunes Radio service. With some $40 billion in cash at the end of the first quarter, there's plenty of time for the company to figure out its strategic problems.

The Down and Outs

Google is a high flyer that everyone loves today. That's a big risk for investors because Wall Street appears to be overlooking notable underlying trends. When sentiment turns, Google shares could fall as rapidly as Apple's have. Apple and Facebook, on the other hand, have both felt the wrath of the market. They, too, face notable headwinds, but at least their shares are trading at sale prices.

Rating: 4.0/5 (1 vote)



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