Adjusting Google Estimates on Higher Expenses

Google (NASDAQ:GOOG) recently announced its Q1 earnings, in which it mentioned that although its revenues showed 27% year-over-year growth, its operating expenses increased at an even faster rate of 35%. ^[1] Investors were disappointed with this result and the stock declined by 5% in after-market trading and has drifted lower since. Management acknowledged the decline in operating margin and reasoned that it will have to keep investing in order to grow its top-line. It seems growing the top-line is a higher priority item for the company, which will also help it compete against the likes of Yahoo (NASDAQ:YHOO), Microsoft (NASDAQ:MSFT), AOL (NYSE:AOL) and Facebook in the online advertising market.

We have updated our price estimate for Google stock from $603 to $576 primarily due to the expectation of lower operating margin for 2011. In spite of the sharp market price decline, our price estimate still stands 5% above market price.

Rising Operating Expenses a Concern

We believe that faster rise in operating expenses are a concern. Management mentioned that the increase in headcount and the one-time salary increase were some of the main reasons for the sharp increase in expenses. Additionally, the greater marketing expense on Chrome browser was another factor that influenced this increase. ^[1] Although these events could certainly bring about a decline in operating margins for 2011, there could be more downside to our estimate for Google stock if margin decline happens in the long term as well.

..But Offset Somewhat by Revenue Increase

In spite of the sharp increase in expenses, Google continues to show steady revenue growth. Although Google continues to dominate the search advertising market, it has started to look at other growth areas as well. These are display, mobile and enterprise.

According to management, the big driver for the display ad business growth is the YouTube, for which revenues doubled since last year. ^[2] On mobile, management didn’t give any update on the mobile advertising revenues, but we believe it is a fast growing business (see Google’s Stock Worth $680 on Mobile Search Growth). On enterprise, the company mentioned that it made strong inroads into businesses and schools through its Google Apps suite of products.

See our full analysis and $576 price estimate for Google

1. Google investor relations, April 14th 2011 [↩] [↩]
2. Listen to the Google earnings conference call webcast, April 14th 2011 [↩]