Google Inc (NASDAQ:GOOG) (NASDAQ:GOOGL) announced both top and bottom line growth in its Q4 2014 earnings release, however it missed analysts' expected earnings growth numbers. The share price dipped on the January 29 release date, but recovered some since then.
It is time to buy Google stock despite the market disappointment? I think it is since the company showed growth in the other main metrics (aside from net income). When the stock story improves for a company, it is usually better to stick with it.
Looking at 12-month figures
Because the company is at the fourth quarter, I will look at the full fiscal year final results to make my observations.
Since much of the value of stocks comes from earnings, it's best to start there. Without any references to analyst expectations, the trend of annual earnings growth is upward and steady.
Google Annual EPS
| 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 | 2013 | 2014 | |
| EPS $ | 2.51 | 4.98 | 6.65 | 6.66 | 10.22 | 13.17 | 14.89 | 16.17 | 19.08 | 21.02 |
Data source: gurufocus.com
The rate of growth has slowed. The five-year annual average growth rate is 15.5%. That's still attractive, but much lower than the 10-year annual growth rate of a compound 26.6%. In fiscal 2014, EPS grew 10.2% from fiscal 2013. This progression worries analysts.
Understanding the R&D breakdown
But to get a feel on why earnings may be slowing, I looked at the amount of research and development that was spent in the full year. For the twelve months ended December 31, the total expense for R&D was $9.83 billion. One year earlier, the value was $7.14 billion.
We can calculate that fiscal 2014's R&D expense was about 37% higher than in fiscal 2013. But if we look at R&D as a percentage of total revenue, that tells us R&D in fiscal 2014 was 14.8% of revenue. In fiscal 2013, that percentage was 12.8%.
Google Annual revenue and R&D expenses
| $m | FY2013 | FY2014 | |
| Revenues | $55,519 | 66,001 | up 18.8% |
| R&D | $7,137 | 9,832 | up 37% |
| R&D as % of | |||
| revenues | 12.80% | 14.80% | |
Data Source: Google Q4 2014 financial data
So if analysts comment about how earnings are slowing, it isn't the case that Google is profiting less from its business on an operating level.
How to look at company earnings
Regularly a company would split its net earnings between retained earnings (the portion invested back into the company) and dividends (the portion paid out to shareholders). The huge portion of revenue Google puts into R&D reduces the operating income, making net income look particularly small.
The R&D funds could be used in the exact same way that retained earnings are when they are plowed back into the business. One difference is that R&D is an expense that reduces taxable income. Increasing R&D decreases the potential tax expense.
R&D development turns into production
The logic behind higher R&D and lower net income becomes clearer. If Google wants to maximise its development funds and reduce avoidable costs, then this is how to do it.
Now, at some point in the future, the need for that high level of development capex may end. Like a mining company finally taking a project from development to operational stage, if Google reached that stage, then R&D could come down, and more income could fall to the bottom line.
From what I see
When you look at Google's current 27 price/earnings ratio versus the 10.2% increase in diluted EPS for the 12 months ended December 31, 2014, you can understand why it's not too high of a PE when you take into account the R&D expenses the extra operating income is going towards.
If the share price gradually comes down from disappointed investor sentiment, like it has over the past several months since last November, then it's time to pick up Google stock now.
