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Google Earnings Miss: Buy or Bail?

Google Earnings Miss: Buy or Bail?

Shares of Google (GOOG) were getting beaten senseless after the company missed on the top and bottom lines when it reported earnings last night. After dropping as much as 6% after hours yesterday, shares have recovered more than half of those losses through the day.

For the quarter, EPS came in at $9.56 per share on revenues of $14.1 billion. Analysts had been looking for $10.80 and $14.4 billion respectively. Below the headline,s the widely followed "cost-per-click" --what the company generates in revenue for every ad clicked-- dropped 6%. Analysts were officially expecting a 4% decline on CPC but were secretly hoping for much better.

With shares up 30% for the year going into last night, the bar was high and Google tripped over it. Still, and this is coming from someone long the shares so take it with a grain of salt, the quarter just didn't seem that horrible.

Scott Kessler, head of technology research at S&P Capital IQ, rates Google a "hold" with a $950 price target and says this latest quarter demonstrates risks in the company's business model that investors have largely ignored recently. Chief among these is the chance that selling ads for mobile devices is simply a bad business.

It's clear that ads on mobile won't command the same premium commanded on desktops. There's going to be a shift from relative high margins per click on desktops to small margins for clicks on multiple devices. The problem with CPC dropping 6% is Google doesn't break out whether the decline reflects a transition to mobile or lack of pricing power in the core business.

"People are to some extent worried about overall pricing when it comes to advertising," says Kessler. The best spin on the CPC decline is a migration to mobile. The alternative would be that the unexpected downward trend in pricing power is, as Kessler puts it, a sign that "maybe all is not as well as people thought."

There are other concerns surrounding the disastrous performance of Motorola Mobility and whether or not the billions Google is spending on the development of new hardware will payoff. Whether or not this pullback is an opportunity or the beginning of the end of Google's day in the sun depends on what you think of their ability to innovate.

Google is trading at about 20-times next year's earnings and has an exemplary track record with new initiatives (Android, Youtube et al). It may not look like a "buy" right now, but the company's history suggests it will be able to successfully overcome the laundry list of headwinds it's facing as a grown-up company.

[Note: Jeff Macke is long Google]

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