A Lot to Like in Google's Second Quarter
Although some of Google's nontraditional products could have smaller margins, they still have strong potential for growth, and the stock remains a suitable core holding for many investors.
Commentary
Google (GOOG) (GOOGL) logged another dependably strong quarter, notable only by a lack of surprises in growth, margins, or pricing metrics. Our core thesis stands, though we acknowledge there may be some unappreciated upside in nonadvertising segments that, while nascent, have strong potential for revenue growth, albeit likely at lower margins relative to the legacy businesses. Still, there was a lot to like in the quarter. We are reiterating our wide economic moat rating, and we're increasing our fair value estimate to account for the time value of money.
Revenue and profitability for the quarter were generally in line with our estimates, as heavy investment in data centers and more nascent products and services (for example, hardware, Google Compute Engine, and Google Fiber) depressed operating margins, in our view. As a sign of strength in the core business, overall revenue increased 21.7%, driven by products such as Google Search and YouTube. Furthermore, growth in clickable ad revenue rose 18% versus 2013's levels, implying greater contribution from display advertising, such as YouTube's TrueView ads, and the "other" segment, including Google cloud-related products and hardware.
Revenue growth from nontraditional products is critical to our valuation model, though we note that most of these services are likely to generate lower margins than the legacy search advertising business. Because of this view, we still expect operating margin improvements to be constrained, increasing from approximately 27% in 2014 to less than 29% in 2018. Still, in this environment, we believe the firm’s wide economic moat, Morningstar Rating of 3 stars, and dearth of relatively attractive stock investment opportunities support the consideration of Google as a core holding for many investors.
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