Google grew revenues 24 fold over the past 4 years. ($440 million in 2002 to $10.6 billion in 2006.) There are two reasons for this. 1) Google started small and dislodged existing large search providers. And 2) search is by far the fastest growing segment of the Internet advertising industry, which grew 34% last year.
But by the end of 2005, Google had captured nearly 2/3 of the search market. It then ran out of market share to easily poach from competitors relative to its new larger size. This is why in 2006, Google increased its market share of searches by only 5.6%, which accounted for perhaps only 9% of 2006 revenues.
One way to view this trend is that the 90%+ revenue growth days are probably over for Google. Another way is to understand that poached business is now only 9% of Google’s earnings — and its winding down can’t affect growth much anymore.
In other words, almost all of Google’s revenue growth now is from the broader demographic shift towards Internet advertising and search. These rates have been constant over the past couple years (and have even been accelerating a bit). Therefore, Google’s revenue growth now looks like it should at hold firm in the 60% to 70% range for the coming few quarters and possibly beyond.
There is also the possibility of revenue upside. Google’s growth will enter a whole new phase if any of the company’s new initiatives like IP video, or G-radio stop being accounting liabilities under development and instead become income-producing assets. Just bear in mind that combined radio and television advertising revenues are about 8 times the size of Internet advertising.
One more thing. I have previously used the word “revenue,” 9 times to emphasize that I am talking about top line growth. I want to point out that Google increased revenue by 2,415% over the past 4 years, while it only increased operating income by 1,904%. This deserves comment because fast growing companies tend to grow profit quite a bit faster than revenues — That is, unless they are ramping up capacity.
And ramping capacity/expenses is exactly what Google warned about last year. That is when the company announced that future operating income would not grow by 2005 levels because it would be increasing spending on new business. In fact, Google even said that 2006 spending growth might exceed revenue growth in a push to develop new initiatives.
So Google is growing revenues with no end in sight and investing aggressively, and Mr. Market could not care less. As a long term Google shareholder this did not bother me. On the contrary, it made me happy that I could increase my position in Google cheaply. You see, I know that: 1) Google will continue to grow revenues in the 60% range because its growth is based on a demographic shift. 2) Earnings are effectively understated because Google’s high level of investment in future growth is not broken down or clearly presented. And 3) This high level of investment will eventually have an high level of payoff.
I know what the guys at Google can do with a few billion dollars — They can (and did) build a Google. With all the new and promising add-ons now under development, at least one of these initiatives is bound to be another hit. Google earned $1.03billion in Q4 2006. The company is capitalized (net of cash on hand) at $140 billion. That comes to an annualized PE ratio of 34… and earnings come out later today.
Andrew Melcher TheOfficialBlog.com
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