Are Clouds Gathering Over Google’s Stock?

Google (NASDAQ:GOOG) has been down nearly 10% following lackluster earnings last month, and by some accounts the outlook is grim for the Mountain View mega-searcher. Despite the innumerable projects and products it has released, Google continues to rely on search as its primary earnings growth mechanism, and while revenues have increasedyear-over-year, it remains unclear whether net income will continue to grow.

Let’s analyze the stock with the relevant sections of our CHEAT SHEET investing framework:

C = Catalyst for the Stock’s Movement

Advertising currently makes up about two-thirds of Google’s total revenue, with mobile advertising accounting for more than half of that. This is, of course, nothing new; we have search and advertising revenues to thank for the ascent of Google’s stock price over the past few years. Yet the prospects for growth remain questionable. Cost per click on ads, or what advertisers are willing to pay Google for each advertising click, has been on the decline for 4 consecutive quarters. Users are half as likely to purchase a product after clicking on a mobile ad, as opposed to a PC ad, and thus far that statistical reality has served as a bargaining chip for advertisers. Google CFO Patrick Pichette also cites “currency headwinds, the balance between developed and emerging markets, the number of ads shown on Google sites versus other sites in its network and changes in types of ads” as factors, but the fact remains: advertising is going mobile, and mobile advertising is less profitable so far.

Meanwhile, anti-trust concerns continue to plague prospects for growth in search. The Federal Trade Commission and European Commission continue to investigate Google for anti-trust violations relating to search, and the favoritism Google allegedly displays towards its own products, (e.g. Google Maps, YouTube, or Google Images). One can only wonder what the growth prospects are in search when the company is already being investigated for anti-trust violations. How much more can Google grow this area of its business without attracting more negative regulatory attention?

Other more popular Google properties – Google Drive, the Android mobile platform, Gmail – are not highly profitable products. They keep Google at the fore in our every day lives, but as we’ve seen from the Facebook IPO, popularity contests don’t generate cash. Google Books had potential, and yet the company seems to have made little progress with that project since Judge Denny Chin rejected the Google Books settlement last year.

Still, Google has some new products on the horizon worthy of consideration…

H = High Quality Product Pipeline for Future Good News is Mixed

Ok fine, Project Glass is pretty cool, but also pretty far from effective monetization. Again, the idea is interesting, but of course that’s not enough. Google’s needs to establish that demand exists for its augmented reality glasses, which allow users to essentially wear smartphones on their face. Google is breaking new ground with this product, and at this point we have no idea what the demand will be.

Aside from the fact that people simply may not want this product, there are a lot of kinks to be worked out. What sort of liability could Google face when a calendar appointment flashes, distracts a driver, and causes a car accident? Will anti-Google Glasses laws follow anti-texting laws? More importantly, if I can’t use these things in my car, what’s point? Now I need the phone, the headphones, and the glasses when I walk out in the morning? God forbid its sunny and I need separate sunglasses. Where the hell do I put my wallet?

Even if a purpose is found for these things, and even if they don’t get people killed in the process, Google Glasses may just go the way of the Segway – weird tech that’s laughed at, not bought. Google will need to address these issues and many more before effective monetization can occur.

Google Fiber, on the other hand, is a promising project that could allow Google to supplant the entrenched ISPs for which so many customers harbor a truly visceral hatred. The Comcasts (NASDAQ:CMCSA) and Verizons (NYSE:VZ) of the world are quasi-monopolistic, inefficient, lobbying machines, and the market would just love a vertically integrated, socially responsible tech giant to replace these crooks. Unlike the other ISPs in the business, Google builds all of its own hardware and has the ability, and more importantly, the desire to run a much more efficient broadband delivery business catering to those fed up with the low-speed status quo.

That said, delivering broadband is not a walk in the park. It’s capital intensive, it takes time to develop key infrastructure, it requires a variety of permits and legal permissions on a locale-to-locale basis, and it assumes penetration into fiefdoms ruled by deeply instantiated ISPs — each of whom would jump at the chance to keep Google out of their backyard, and probably have ways of doing so. Most importantly, it means developing expertise in fiber, which is not exactly Google’s bread and butter, though to some extent that process has already begun. Google has been working on developing its own hardware since 2010, and after two years the service is now available in Kansas City. It will be years before the service pays for itself and generates the kind of income that can supplant, or even supplement Google search revenues; but, eventually it could do both…

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T = Trends Provide Questionable Support for the in Which Industry Google Operates

For years, Google has represented all things new, techy, and forward thinking. Yet the biggest trend to speak of is the shift to mobile, which remains at best a mixed blessing for Google. Google makes significantly less money on each mobile ad it sells as compared to each PC ad it sells, even as mobile ad sales have begun to dismantle the very engine of growth that made Google supreme. And what will replace PC search as a contributor to Google’s bottom line? It would appear to be mobile search, which now represents the largest single revenue stream contributing to Google’s earnings, as the desktop market wanes, and the smartphone and tablet markets thrive.

But how will mobile search replace PC search when the cost per click on ads has been in decline for 4 consecutive quarters, largely the result of lower mobile ad prices? How can it do so when, despite having 75% of the smartphone market, Android accounted for just 5.5% of Black Friday web traffic, according to IBM?  Android’s continued success is cited tirelessly as a positive factor for growth in Google’s ad revenue, yet increases from Android must be discounted by losses in cost per click, contextualized as a less profitable business cannibalizing a more profitable one, and sobered by the reality that Android users simply spend less money than Apple (NASDAQ:AAPL) iOS users.

After all, Android phones are cheap –is it really so surprising their users are cheap too?

The picture for Google grows gloomier when we realize that all of this assumes Google will actually continue to indefinitely increase its Android market share at the current pace, which by the way, is impossible. With fierce competition from Apple, any substantial market share increase may be difficult. Android already makes up as much as 75% of the smartphone market; how much room for growth is there? At best, Google can continue to “win” the mobile war, which really means replacing a more profitable business with an unprofitable one, and then some how convincing advertisers that mobile search suddenly deserves much higher prices. At worst, Google faces increasingly fierce competition from Apple’s Siri — and other apps that Google’s search algorithm can’t crawl — as Google PC search market share is cannibalized by mobile search, and as Google pays revenue-sharing payments for Mobile Safari traffic on Apple’s iPhone.

Google search may be entrenched, but its tough to see how it can be poised for growth.

At the same time, computing is also moving to the cloud, another major trend in the industry. Google has done much to take advantage of this shift, and is currently competing with companies the likes of Amazon (NASDAQ:AMZN), Rackspace (NYSE:RAX), and Microsoft (NASDAQ:MSFT). Google’s entrance into the market with Google Drive was welcomed, but effective monetization is clearly an afterthought as Google engages in a price-slashing war with Amazon for market share of the cloud…

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S = Support is Provided by Institutional Investors and Company Insiders

Everything up to this point tells you just one thing: sell. But we can’t forget the technical factors. The market appears to have priced in much of its recent disappointment with Google, and perhaps even overcompensated. Value investors may be concerned for the company’s future, but short-term traders might see opportunity. Soros Fund Management seems to agree, having recently added a position in the company. Given the fund’s history of buying and selling Google stock, its not unlikely that the intention is to turn a profit on a market correction. So maybe Google is a technical play, but that’s about it.

Conclusion

An investment in Google has to be about one of two things at this point: a long-term investment on the promise of Google Fiber, or a short-term investment premised on a looming market correction. Google has found support at its 200-day moving average, and while its PE remains slightly above average at around 20.93 after a 10% drop in share value, that’s not historically high for Google. Large investors may view this as an opportunity to profit from a market correction, and smaller investors might try to ride that wave. Current shareholders might find it worth the wait, either to take some quick gains with the search giant on a market correction, or hold out for Google Fiber. Either way, right now it’s unclear whether adding a position now is even worth the sales commission, so I’m going to WAIT AND SEE.

Using a solid investing framework such as this can help improve your stock-picking skills. Don’t waste another minute — click here and get our CHEAT SHEET stock picks now.

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