$GOOG Q2 Earnings Preview

by Enis July 17, 2013 12:27 pm • Commentary

Event: GOOG reports Q2 earnings Thursday after the close.  The options market is implying about a 4.5% move, which is lower than the 4 qtr avg move of 5.25%, and lower than the 8 qtr avg of about 6.5%.

Sentiment:  Wall Street is fairly positive on the stock, with 34 buys, 14 holds, and 1 sell, with an average 12 month price target of ~$986.

Options Open Interest:  Total open interest is basically evenly split between calls and puts, with 224k calls of vs. 221k of puts.  Recent activity has been slightly skewed towards calls (1.2 to 1 over the past month) as the stock is up to all-time highs.  

Fundamentals:  GOOG is a 25x trailing P/E stock (20x forward) expected to grow earnings at 15% per year.  The valuation is reasonable.  The key is execution.  One of the main advantages GOOG has is that it’s the behemoth in online advertising, so it gets to dictate the terms of the market and adjust accordingly, and most others have to accommodate GOOG.

One area of concern for GOOG has been the decline in online advertising rates for traditional display ads over the past 2 years.  That was part of the reason for their poor Q3 result in 2012 that halted the stock’s strong momentum last year.  However, one gem for GOOG in the shift in the online advertising landscape is YouTube.  YouTube is the leader in online advertising by a large margin.  See comScore rankings from earlier this year.

While the other bells and whistles of the GOOG business (Google Glass, driverless car, solar power, and even including Android) are interesting endeavors, the bread and butter of the business is still online advertising.  But GOOG has not neglected the internet.  It has increasingly captured diverse user sets with its innovations (including Google Hangouts most recently), and is well positioned for further growth in global internet usage.

All that being said, one key for GOOG will be international revenues.  GOOG gets about 55% of its revenues from outside the U.S.  We’ve heard from several large multinationals already (ORCL, KO, etc) that international slowing has hurt their business.  GOOG is pro-cyclical, and was likely impacted as well.  In addition, GOOG is now a $300 billion market cap.  We’ve seen historically that companies this large start to have a difficult time meeting ambitious earnings targets since the actual earnings needed to produce growth substantially increases.  That could be a concern for stock appreciation going forward.

Price Action / Technicals:  The long-term picture in GOOG shows that the stock convincingly broke above its prior $750 all-time high level in the spring, retested it in April, and has been in a strong uptrend ever since:

7 year weekly chart of GOOG, Courtesy of Bloomberg

On a short-term timeframe, the 1 year chart shows the steady uptrend since last summer.  The trend has gotten steeper in 2013, which I’ve marked with a smaller green line:

[caption id="attachment_28221" align="alignnone" width="645"]1 year daily chart of GOOG, Courtesy of Bloomberg 1 year daily chart of GOOG, Courtesy of Bloomberg[/caption]

There is no resistance above the 928 high earlier this week.  Strong support is around the $850 level.

Volatility Snapshot:  GOOG 30 day implied volatility (red) is at its lowest level in the past year ahead of its earnings event:

1 year chart of 30 day implied vol (red) vs. 30 day realized vol (blue), Courtesy of LiveVolPro

While recent realized vol (blue) in GOOG has been low, it’s close to where it was prior to previous earnings reports.  Options traders are expecting less of a move, even with GOOG at all-time highs.

MY VIEW:  GOOG has been a large-cap growth favorite among fund managers this year.  It is up around 30% in 2013, quite a performance for such a large market cap stock.

GOOG is very well positioned for the long-term secular trends taking place in the internet realm.  They’ve been especially nimble about pivoting as advertising has shifted towards video and likely more towards mobile.  Valuation is not much of a concern given the expected growth rates.

The main concern is achieving those projections.  Strong performance in the international business would be a solid sign that global slowing is not affecting GOOG nearly as much as other multinationals.