Google’s (GOOGL, Financial) stock has lost a little over 11% during the last year. In recent times, growth has slowed in Google’s core advertising business, with ad rates (mainly CPCs or the Cost Per Click) falling consistently. Additionally, the rise of Facebook Inc (FB, Financial) as an advertising platform hasn’t helped Google. While Google still remains a strong company fundamentally, there is evidence of mounting pressure on the search giant.
Armed with the largest share of global digital advertising spends, Google still leads the pack by a huge margin. Further, Google valuations indicate a 15% upside potential in 2015. However, Google might need to unveil its next growth driver to turn investor sentiment around.
Slowing growth, falling CPCs and growing competition in the online advertising space seem to be taking a toll on Google’s stock, which has lagged major indices by a significant margin over the last 12 months.
Google’s Core Business Growth Has Slowed
The slowdown in Google’s ad-revenue growth is probably the biggest concern for investors. The search giant’s core business has been its growth engine thus far and a slowdown in the face of growing competition might be fuelling concerns.
Google’s ad-revenue growth rate came in at 18% YoY in Q4 2014, down from 23% in Q2 and 20% in Q3. Even in terms of absolute YoY revenue addition, Google has slowed in the last two quarters of 2014. This is an unusual trend, especially in Q4, where revenue addition has spiked in the past couple of years.
Let’s be clear: to pull in the kind of revenues that Google does is no mean feat. However, the slowdown and growing competition could continue to dampen investor sentiment around Google, even though the company might continue to deliver sizable revenue numbers.
Google’s CPCs Have Fallen Drastically
We all know that Google’s CPC rates have been falling for a while now. We used Google’s sequential CPC movements to construct this graph based on a hypothetical base value of 100 at the beginning of 2010.
Google’s CPC has fallen by 23% over the last four years. Google’s ad-revenue growth has been driven by a near 200% growth in paid clicks during this phase. Being the world’s number one search engine, it’s likely that paid clicks will continue to drive ad-revenue, as internet penetration increases globally.
However, CPCs tend to be much lower in emerging economies, implying that the growth in paid clicks might not translate to a proportional growth in revenue. Further, with increasing competition from the likes of Facebook, Google’s CPCs might continue to decline. This could possibly make investors a little uncomfortable.
One of the contrasting views about Google’s falling CPCs is that it could encourage advertisers to spend more on Google’s advertising platform and help the search giant grab market share. Google does account for a large chunk of digital ad spends, with Facebook coming in at a very distant second position. However, projections by eMarketer indicate that Google’s share of global digital ad-spends might in fact be contracting, while Facebook’s share expands.
The table shows net digital ad-revenue share worldwide, as per eMarketer.
| Ă‚ | 2013 | 2014 |
| 31.55% | 31.10% | |
| 5.75% | 7.75% |
Source: eMarketer
Google Valuations
Google currently trades at $535 a share. On an LTM basis, Google’s P/S and adjusted P/E ratios stand at 5.6 and 21.1 respectively. Our Google stock analysis indicates that valuations are cheap compared to the industry average multiples.
Analysts expect Google to deliver a revenue of $75.64 billion in FY 2015, growing at a little under 15%. Analysts are forecasting Google’s FY 2015 revenue growth to be slower than 17.4% in 2013 and 19.13% in FY 2014 (growth rates based on revenue excluding Motorola Solutions Inc (MSI, Financial)).
At its current P/E and P/S ratios, based on 2015 revenue estimates, Google could offer an upside potential of about 12.3% to 14.6%. However, any disappointments in the coming quarters could mean that Google could trade at lower valuations, wiping out that potential upside.
Closing Thoughts
Google is still a fundamentally solid company and has delivered decent numbers in 2014. Its FY 2014 revenue growth of 19% on a $55.4 billion revenue base (ex-Motorola) is commendable. Further, Google’s average net margins of over 20% during the year are not far lower than its average levels in 2013 and 2014.
Google is still the world’s number one search engine and that’s not going to change any time soon. It’s very likely that Google will continue to deliver decent revenue growth and profitability in 2015. However, if growth rates start to slow significantly, Google might attract lower valuation multiples, translating to a lackluster return for investors. With competitors piling on the pressure in the advertising space, Google might need to unveil its next growth driver to reverse investor sentiment.
