$GOOG Q2 Earnings Preview

by Enis July 16, 2014 1:18 pm • Commentary

Event:  GOOG reports Q1 earnings tomorrow after the close.  The options market is implying about a 4.25% move, which is below the 4 qtr avg move of 5.75%, and the 8 qtr avg of about 5.25%.

Sentiment:  Wall Street analysts are very positive on GOOG, with 40 buys, 12 holds, and NO sells, and an average 12 month price target of $659d.  Quite rare to have a company as widely followed as GOOG, with no sell ratings. Short interest is negligible at around 1% of the float.

Options Open Interest:  Total open interest favors calls over puts by a ratio of about 1.15 to 1 for GOOG (combined for GOOG and GOOGL).  The one month average volume has favored calls over puts by a ratio of around 1.5 to 1.  The $600 strike is has the most open interest in July, at over 3k on the call line in GOOGL.  For GOOG, the Sept 610 calls have over 4k of open interest.  The high earlier this year (which is the all-time high) was $615.  
Price Action / Technicals:  The spring selling earlier this year never broke the rising 50 week moving average, and GOOG remains in a long-term uptrend as long as that level holds (now around $533):
[caption id="attachment_42974" align="alignnone" width="600"]GOOGL weekly chart, 50 week ma in pink, Courtesy of Bloomberg GOOGL weekly chart, 50 week ma in pink, Courtesy of Bloomberg[/caption]

On the daily chart, we can see the relevance of the big figure levels, as $550 is first support on the downside, while $500 is of more long-term importance.  On the upside, $600 has not been breached since March:

[caption id="attachment_42975" align="alignnone" width="600"]GOOG daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg GOOG daily chart, 50 day ma in pink, 200 day ma in yellow, Courtesy of Bloomberg[/caption]


Fundamentals/Valuation:  GOOG is up about 6% since just prior to its mid-April earnings report, lagging the broader market and tech stocks in particular.  Fundamentally, not much has changed, and what I wrote in last quarter’s preview still applies:

GOOG’s appeal among the investment community over the past few years (GOOG has doubled since June 2012) is that it’s one of the few mega cap stocks in the U.S. that offers double digit earnings growth.  In fact, GOOG has grown earnings AND sales at least 10% in every year since the stock IPO’ed back in 2004.  That’s quite a feat, especially for what is now a $375 billion market cap company.

GOOG is expected to grow sales and earnings at a double digit pace for the next few years as well, and the company is centrally positioned to take advantage of the long-term shift in advertising to online platforms.  The real question with GOOG, as with many growth stocks, is whether it’s a good value at current levels.

At the recent Google I/O developers’ conference, the company emphasized the revenue potential for Android over the long run.  Online advertising is still the source of over 80% of total revenues, but Google has been making gradual inroads with Android as well.

As for valuation, it seems reasonable at around 32x for 15-25% expected EPS growth, though GOOG’s size might make it more and more difficult to grow the business.  Whether competitors make more of an inroads into online advertising or GOOG maintains its substantial moat in the space is one critical issue for investors.

Volatility Snapshot:  Options traders are expecting much less volatility in GOOG on this earnings report compared to last quarter:

[caption id="attachment_42980" align="alignnone" width="600"]GOOGL 30 day implied volatility, Courtesy of Bloomberg GOOGL 30 day implied volatility, Courtesy of Bloomberg[/caption]

Of course, the main reason why implied volatility moved so high in early April is that GOOGL was selling off towards its 200 day ma for the first time in nearly a year.  At this juncture, the stock is back near all-time highs, in a grinding uptrend.  Barring a surprise, the implied volatility is likely to fall back into the high teens.

Our View:   GOOGL has traded as half momentum stock / half tech leader in 2014.  It has held up much better than most growth leaders, and is still up 6% year-to-date.  However, it has lagged many of the mega cap tech stocks (AAPL, INTC, CSCO, MSFT, FB, etc.) year-to-date.  We don’t expect a major surprise on earnings, though the bar is set quite high for this report – 31% year-over-year growth, which would be the largest EPS growth since Q2 2011.  That’s mainly due to a weak Q2 2013 number, but nonetheless, no easy beat.  The real trade here might be after earnings, as implied volatility in the high teens is likely a buy in Google given the way the small cap growth stocks have started to move in the past week.