Most public companies provide forecasts of revenue and earnings in the upcoming quarters. These forecasts (sometimes called "guidance") form the basis of the work most stock analysts do to make buy and sell recommendations. Much to the consternation of these analysts, Google is among the few companies that have refused to follow this practice. As a result, estimates of Google's revenue by analysts using publicly available data, like comScore numbers, have often been spectacularly wrong. Today's earnings call may be no different.
A Google executive once explained to me why Google doesn't provide forecasts. To understand it, you have think about the engineers at Google who work on optimizing AdWords. How do they know they're doing a good job? We know that Google is constantly bucket-testing tweaks to their AdWords algorithms. An ad optimization project is considered successful if it has one of two results:
- Increase revenue per search (RPS), while not using additional ad real estate on the search results page (SERP).
- Reduce the ad real estate on each SERP, while not reducing RPS.
The tricky cases are the ones that increase RPS, while also using more ad real estate. It then becomes a judgment call on whether they should be rolled out across the site. If Google were to make earnings forecasts, the thinking went, there would be huge temptation to roll out tweaks in the gray area to make the numbers. As the quarters roll by, the area of the page devotes to ads would keep steadily increasing, leading to longer term problems with customer retention.
Of course, this doesn't mean there is no earnings pressure. In reality, whether they issue guidance or not, Google's stock price does depend on whether they continue to deliver robust revenue and earnings growth. So implicitly, there is always pressure to beat the estimates. And for the first time, as Google's stock has taken a hammering in recent months, I've heard about hiring slowdowns at Google. So there is definitely pressure to cut costs as well. It will be interesting to observe the battle between idealism and expediency play itself out, with its progress reflected in the ad real estate on Google's search results. It's easy to be idealistic with the wind behind your back; the true test is whether you retain the idealism in the face of headwinds. Time will tell.
This brings us to today's earnings call. In my experience, the best predictor of Google earnings has been Efficient Frontier's excellent Search Engine Performance Report. EF is the largest ad agency for SEM advertisers, and manages the campaigns of several large advertisers on Google, Yahoo, and Microsoft. As I had noted earlier, in Q1 an estimate based on their report handily beat other forecasts, most of which use ComScore data. (Disclosure: My fund Cambrian Ventures is an investor in EF.)
EF's report for Q2, released this morning, indicates a strong quarter for Google. Google gained more than its fair share of advertising dollars in Q2 2008. For every new dollar spent on search advertising, $1.10 was spent on Google, at the expense of Yahoo and Microsoft. In addition, Google's average cost-per-click (CPC) increased by 13.8% in Q2 2008 versus Q2 2007, while click volume and CTR increased as well. And, there was strong growth overseas as well, which should help earnings given the weak dollar.
I don't have the time right now to do the math and figure out whether the robust performance was sufficient to beat the Street's estimates. You should read the report for yourself and make that call.
Update: Google's results, although robust, were below expectations. The biggest moment in the earnings call for me was this quote from Sergey (via Silicon Alley Insider):
Sergey said the company may have overdone its quality control
efforts in the quarter (reducing the number of ads), and the reversal
of this could provide a modest accelerator to Q3
Quality efforts "overdone"? Apparently those pressures are telling after all, and Google is going abandon their principles a wee bit to venture into the grey zone. Is is the start of a slippery slope?
Sergey said the company may have overdone its quality control efforts in the quarter (reducing the number of ads), and the reversal of this could provide a modest accelerator to Q3