What's Driving Google to New Highs?
It was only last November when Google (NASDAQ: GOOG) traded below $650. Now, shares trade around $826. Much of this 25% gain could be attributed an overall positive market (note the 15% rise in the Dow Jones during the same period). But what's causing the rest of the tech giant's rise?
To understand what drives Google's stock price (or at least what should drive Google's stock price), it's important to break down its revenue to see which of its units really count in analysis.
Google's network sites and its Google.com revenue make up the majority of revenue, at 25% and 62%, respectively. To better understand each of these segments, it's first necessary to get a grasp of the difference between Google's AdWords and AdSense programs.
- AdWords: Google's primary auction-based advertising program, used to deliver relevant ads to search queries or web content. These text-based ads appear beside related search results or web content on Google's own sites (Google.com) or on the thousands of Google's partner websites (Google network).
- AdSense: Enables Google's network partners to deliver relevant ads from AdWords advertisers on their websites.
In other words, AdWords customers pay Google to advertise, while AdSense customers get paid by Google to deliver AdWords advertisements to relevant audiences. Google makes money from the spread between the amount AdWords customers pay and the amount AdSense customers receive.
Google reports all advertising revenue that goes toward ads on its own site under the label "Google.com." Likewise, all advertising revenue that goes toward ads on network partners' sites is labeled "Google network sites." This is appropriate, considering that the company shares "the majority of the revenues generated from [AdSense program ads] with the Google network members that display the ads," as stated in the company's 2012 10-K.
In short, advertising is what drives Google's business. Google Glass, the Chromebook Pixel, and driverless cars are all nice -- but none of these playful items meaningfully impact business results.
Key metrics driving growth
With so much depending on advertising, Google investors pay particularly close attention to cost-per-click and paid clicks -- two metrics that speak volumes about Google's success in advertising.
- Cost-per-click, or CPC: The amount an advertiser pays Google when a user clicks on an ad.
- Paid clicks: The quantity of clicks on sponsored links.
Paid-click growth came in nice, increasing 24% in Q4 from the year-ago quarter. But the real surprise was the changing trend in CPC.
Before Google's fourth quarter results, investors were looking for a bottom to Google's declining year-over-year CPC comparisons. In the second quarter of 2012, CPC year-over-year comparisons reached an all-time low of negative 16%. The next quarter brought little improvement, with year-over-year CPC comps coming in at negative 15%. Finally, investors saw a significant upturn in the fourth quarter of 2012, with CPC year-over-year comps declining just 6% (only 4% once adjusted for currency impacts).
The Street interpreted this smaller decline in Q4 to signal a bottom to the negative CPC trend.
At the time of the earnings release, this seemed to be one of the major drivers of the new optimism toward Google's stock. But as the months progressed, Google's success with YouTube drew attention as well.
Though it's tough to gauge the exact impact of YouTube on Google's advertising revenues and profits, since the company doesn't report YouTube revenues as a separate segment, it is very clear that it plays a huge role in driving Google's business. Several comments from Google's fourth-quarter earnings call paint YouTube as a major growth opportunity for the company.
"YouTube Partner revenue has doubled for the fourth consecutive year, and thousands of channels are now making six figures annually," said Nikesh Arora, Google's chief business officer. "On YouTube, our top 100 global advertisers spent over 50% more in 2012 than they did in 2011."
Arora went on to explain that a significant factor in this growth stemmed from the implementation of Google's TrueView skippable ad format, where advertisers only pay if viewers watch ads. This growth driver has plenty of runway left, considering that it was only during the fourth quarter that TrueView came to Xbox, iPad, and the Wii.
Is the Street too optimistic?
Google's increasingly lofty valuation at 25 times earnings hasn't convinced me to end my outperform CAPScall on the company yet, but it has sent me looking in new places for value in online search.
China's search king, Baidu (NASDAQ: BIDU), has seen its stock fall more than 15% since its fourth-quarter earnings release. Now the stock trades at just 18 times earnings.
Even more intriguing, Baidu is still growing by leaps and bounds, reporting a 41.6% increase in fourth-quarter revenue from the year-ago quarter. Compare that to Google's 19% and 18% year-over-year increases in network and Google.com revenue, respectively.
A reversing trend in declining CPCs and a fast-growing YouTube are definitely indicators of a bright future for Google in 2013 and beyond. But when growth is already priced into the stock so heavily, I'm forced to get out my crystal ball. Unfortunately, my crystal ball hasn't proved very effective.
In the meantime, I'll make my outperform CAPScall on Baidu a top pick.
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