Google 2006 1st Quarter Analysis

In the previous article on Google growth rates we found that the growth rates are going to slow down to 60-70% a year in 2006. Two days back we looked at Yahoo! report and analyzed the results.

As we had forecast, Google earnings growth has slowed down to 60% year over year. The top line revenue and earnings growth were both above the average analyst forecast. This caused the stock to jump by 5.33% on Friday, the day after the earnings were released. Several analysts re-iterated their buy rating - let us take a look to see how things look like this quarter.

First the good part about the earnings report. Google increased its market share over both Yahoo! and Microsoft. Increasing market share is going to put more pressure on the competitors and is going to improve Google's competitive position. In the long term, market share is going to make the difference.

The operating margins declined to 32.95% from 34% from the previous year. The stock dilution year over year was 6%. This doesnt include the 2% dilution expected through the secondary stock offering. The company expects dilution due to employee stock awards to be in 1 - 1.5% range every year. This means the company will be issuing 3 - 4.5 million shares overall to current and new employees. The capital expenditures are also expected to increase for the rest of the year. From the earnings report, "We expect that the growth rate in capital expenditures in 2006 will be substantially greater than the revenue growth rate for the year. We expect the majority of investment to be focused on IT infrastructure including servers, networking equipment, and data centers, as well as real estate and campus facilities."

The company also benefited from a lower tax rate this quarter (27%). In the quarterly report, the company said that the tax rate is likely be higher at 30% for the entire year including this quarter. Google also increased its headcount by more than a thousand in the three month period between December and March. This is going to increase the expenses further. The book value of the company is about 33 dollars as the share holders equity rose by about 10% year over year.

To sum up, Google had a great quarter and gained market share. However, the company is expecting expenses to be higher for the rest of the year. In addition, the stock dilution is going to show up in the upcoming quarter. Expect the turbulence to continue in this stock for the rest of the year. At this time, the stock is fully priced and the slow down in profits is not fully reflected in to the stock. CNBC and few analysts were looking at proforma earnings where as one has to look at diluted EPS to get a real view into the business. We expect the competion to get tougher in the next year as Microsoft and Yahoo! roll out their own adsense programs.