Google Ad Revenue Slowdown Is Hurting Valuations

  • Google ad revenue growth has slowed with a 23% decline in CPCs in 4 years.
  • Google's Paid Clicks growth has driven ad revenue growth.
  • Google valuations are attractive, but growth risks could threaten upside potential.

Google (NASDAQ:GOOG) is down by over 7% in the last twelve months and its slowing core business might be the reason for the decline in Google valuations. In recent quarters, growth in Google’s advertising revenue has slowed and ad-rates or CPCs have fallen consistently for an even longer period of time. Meanwhile, competition in online video advertising has grown with Facebook’s rise as a prominent advertising platform, mounting pressure on the search giant.

Google is still a fundamentally strong company, armed with the largest share of global digital advertising spends, followed by Facebook (NASDAQ:FB) in a distant second position. Further, our Google stock analysis shows that Google valuations aren’t expensive when compared to its industry average, implying an upside potential. However, to turn investor sentiment around and sustain its valuation multiples, Google might need to unveil its next growth driver.

Google Stock Performance

Slowing growth, growing competition and falling CPCs have hurt Google’s stock price. As a result, Google has significantly underperformed major indices like the NASDAQ Composite and the S&P 500 in the last twelve months.
GOOGL stock chart
Google stock chart by amigobulls.com

Let’s start by looking at how Google’s core business has performed. 

Google Ad Revenue Growth Has Slowed

At the heart of Google’s revenue model, is its core business of advertising. Understandably, the biggest worry for investors might be slowdown in Google’s growth engine, in what has traditionally been its strongest quarter.

Google’s ad-revenue growth rate declined to 18% YoY in Q4 2014, from 23% in Q2 and 20% in Q3. Even in terms of absolute YoY revenue addition, Google’s ad revenue growth has slowed in Q3 and Q4 2014. As the graph below would highlight, this is an unusual trend, especially in Q4, where revenue addition has spiked for the last couple of years.

Google YoY Absolute Revenue Addition

Undoubtedly, to rake in the kind of revenues that Google does is no mean feat. However, in the face of growing competition, a slowdown is always a worry for investors.

Google might continue to deliver the sizable revenue numbers that we have come to associate with the company. However, if the trend continues, it is likely to dampen investor sentiment around the company’s growth trajectory, and thereby, its valuations.

Google CPCs Continue To Fall

Moving on to the more important trend of Google’s falling CPC rates, we all know they’ve been falling for a while now, but by how much? We used Google’s quarterly CPC changes to construct this graph based on a hypothetical base value of 100 at the beginning of 2010. Google CPCs have fallen by 23% over a 4 year period since 2010. In the same time frame, Google’s Paid Clicks have grown by 196%.

Google CPC Decline and Paid Clicks Growth Chart

Obviously, the 3X growth in Paid Clicks has driven Google’s ad revenue growth during this phase. Being the world’s number 1 search engine, it’s not unlikely that Paid Clicks will continue to grow as internet penetration increases globally.

That said, CPCs are typically lower in emerging economies, which are likely to be the prime candidates to drive internet penetration. The implicit message here is that growth in Paid Clicks may not translate to a proportional growth in ad revenue for Google.

What’s more, as we pointed out in our recent post on the Google vs Facebook comparison, Facebook has made some headway in the online video advertising space. With growing competition from the likes of Facebook, Twitter and Yahoo among others in the advertising space, Google CPCs could remain under pressure, and possibly continue to decline.

Google Market Share Of Global Ad Spends

A contrary view suggests that Google’s falling CPCs could entice advertisers to increase their spends on Google’s advertising platform and drive Google’s market share. While Google does account for a big chunk of global digital advertising spends, projections by eMarketer indicate that Google’s market share might actually be contracting.

2013 2014
Google 31.55% 31.10%
Facebook 5.75% 7.75%

Source: eMarketer

Google Valuations

At $559 a share, here’s what Google valuation multiples currently look like:

  • Google PE ratio: 21.9
  • Google Price to Sales ratio: 5.6

To project what Google’s stock could be worth at the end of the year, let’s look at analyst estimates of Google’s revenue and EPS for 2015.

Google Revenue Estimates: Analysts expect Google’s 2015 revenue to come in at $75.6 billion, growing at about 14.5%, which is slower than the 17.4% growth in 2013 and the 19.1% growth in 2014.

Google EPS Estimates (Adjusted EPS): Analysts expect Google’s adjusted EPS to grow to $28.7 a share, up from $25.6 a share in 2014.

Assuming Google meets those targets and continues to command its current PE and Price to sales multiples, Google valuations could have an upside potential of 12.2% to 14.5% in 2015.

That said, any disappointments from Google during the year could lead to a contraction in valuation multiples, potentially wiping out any upside potential.

Closing Thoughts

Google is still the world’s number 1 search engine, has the largest share of digital ad spends globally, and neither of that is going to change any time soon. Google’s revenue growth of 19% on a revenue base of $55.4 billion Dollars in 2014 is commendable, and its FY 2014 net margin of over 20% is not far from its average levels in 2013 and 2014. Google is still a strong company fundamentally.

It’s very likely that Google will continue to deliver decent growth and profitability in 2015 as well. However, if growth rates do slow down significantly, Google’s valuations multiples could shrink, translating to marginal returns for investors. With growing competition, Google might need to unveil its next growth driver to reverse investor sentiment.

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Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice. Buying and selling of securities carries the risk of monetary losses. Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions. Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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