Earnings Preview: Will Google Perform?

On Thursday, Google will report its Q1, 2008 earnings. There is rampant speculation about whether Google will perform, and with April options expiring one day after earnings are released, we can get get a sense of what the investing population thinks as a whole.

Call options are slightly higher than put options, suggesting that the market believes they will perform well and the stock will edge higher after earnings are announced. Once again, I am a contrarian and believe the shorts have it right. Why? There are several reasons why I believe Google will disappoint:

Ad revenue, the main driver of Google’s earnings power, has been performing worse-than-expected in the past few months. Google says it’s because they’ve reduced the number of “false positives” that advertisers were paying for, and that the changes they made help advertisers obtain more quality clicks. First off, I don’t buy that this is the reason for the decline. Sure, it might have exacerbated it, but what about the fact that FireFox is gaining in popularity, and they have a plugin that blocks the javascript that Google Adsense uses? That is certainly playing a role, and that role will only get bigger. Not only that, but many companies are seeking to circumvent Google altogether, making deals with advertisers themselves. That’s exactly what we’re doing here at Freund Investing.

Additionally, Google was, in the past, the only player in the advertising space. Many competitors have stepped up to the plate and are looking to get a slice of the large advertising pie, decreasing Google’s market share for those who haven’t ventured out into the advertising realm on their own.

Lastly, and perhaps most importantly, many businesses throughout the United States are facing reduced sales and, consequently, reduced advertising budgets. This will affect Google’s total revenue both in Q1 and for the remainder of 2008.

With a price-to-earnings ratio of 33.5, a serious earnings miss will be punished severely. It is not our belief that Google will miss by a large amount, but it is certainly not out of the realm of possibility. If Google does, by some miracle, surpass expectations, that might be a good opportunity to start a short position.

Freund Investing Managing Member Ryan Freund holds no position in any of the companies mentioned in this article. Freund Investing has a solid Disclosure Policy.