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Is Google's Growth Sustainable?

Jeremy Glaser

Jeremy Glaser: For, I'm Jeremy Glaser.

Google's winning streak continued in the third quarter. I'm here with analyst Larry Witt to take a closer look at their results. Larry, thanks for joining me today.

Larry Witt: Thank you.

Glaser: So what did you think of this quarter?

Witt: I thought it was a pretty strong quarter actually. Revenue growth came in higher than I was expecting, as well as what The Street was expecting, and I think it really shows that their momentum continued.

Glaser: So what were some of the drivers of that revenue growth being better than you thought?

Witt: So revenue growth was about 23%, and I think a couple of things that are benefiting Google right now is one, they're still benefiting from the secular shift, market share gain from traditional media, just more companies allocating more of their ad budgets online, and that's probably going to persist for sometime.

But in the short run, they're also benefiting from this rebound in advertising. Advertising really fell off a cliff during the recession. They're already getting the additional short-term biz data. Once comps become a little bit more difficult in the coming quarters, I think you'll see their revenue growth slow down a little bit.

Glaser: So do we think that corporate advertising is now back for real, for good?

Witt: Well, it definitely has been coming back for the last few quarters, pretty strong across the board excluding certain categories like newspapers and magazines that may never grow again. But I think it is back. It may not get back to the levels it was at a couple of years ago--that may take some time--but it does appear to be sustainable at this point.

Glaser: You alluded to the fact that you think this revenue growth might not be sustainable over the long term. What do you think Google is doing to try to kick start that growth engine again?

Witt: Yeah, absolutely. They are, as many people know, investing in a number of other business lines outside of just core search. They are trying to get bigger into display advertising, competing with the likes of Yahoo and AOL. They are trying to become a bigger player in the mobile space as well. I think you're starting to see contraction in those areas. They talk about a number of clients they are gaining and traffic and number of other metrics are improving. I don't think we're at the point yet where it's really impacting their financials, because search is such a large business for them. But I do think some of these areas will be interesting for them but will probably never equal the size of search.

Glaser: Larry, we have heard a lot about some Google projects that maybe are far away from search, like driverless cars and alternative energy investments. What do you think is behind these? Is this just a waste of shareholder money or is it something that could eventually actually produce meaningful growth for the company?

Witt: I think one thing to think about with these auxiliary investments, if you will, is the fact that the company has always said, look, we are making decisions in investments for the next five, 10 years or longer; we are not worried about quarter-to-quarter. That's kind of the mantra they've had since going public.

But I think it's more than that. I think they probably know that some of these investments will never work out. I think, first, they're probably just trying to improve employee retention; a lot of the people that work at places like Google, they like to work on interesting projects, whether it'd be on a full-time basis or kind of on temporary basis--Google is notorious for their 20% time, where they're allowed to work on any projects they want for 20% of the time.

I also think it's probably just in the interest of the founders. The two founders of the company still control a large percent of the company, and they're probably personally interested in some of these activities, and they're not necessarily thinking first and foremost of the shareholders all the time, but rather trying to pursue ideas that they think might not necessarily pay back shareholders but may be pie in the sky thought processes, like, Oh! How can we change the world, and not worry so much about how we're going to make money.

Glaser: And Larry, quickly, what do you think about the valuation of the stock?

Witt: It's fairly close to our fair value estimate. Our fair value estimate is $550. We may raise it slightly just based on the momentum they've had in the past couple of quarters doing a little better than we expected. But we think the current price is fairly close to what we think the company is worth.

Glaser: Great. Larry, thanks for taking the time today.

Witt: Thank you.

Glaser: For, I'm Jeremy Glaser.