Google Earnings: Revenue Grows, but Company Seems Stagnant [Update]

Google (GOOG) announced its earnings for the second quarter, but relatively good news won't keep analysts happy. The 24 percent year-over-year growth was below analyst expectations. Of greater concern to Google's strategy is that it seems to struggle whether to make money or be loved.

Google's big strength but also challenge is the source of its money. Advertising produces between 96 percent and 97 percent of the company's revenue. Ads provide significant income and, because of their nature, sell themselves to a significant extent. Google can allow new lines of business time to establish themselves without concern about a drain on resources.

However, the gravy train has slowed pace, as the chart below shows:

In tech, slow growth is usually the kiss of death. When a company is a one-source revenue machine, it's even more of a worry, because any stalling in the primary financial lifeline could mean a big disruption. That might explain why Google shares are down 3.5 percent in after hours trading:

But reaction to earnings announcements tends to focus on the negative, and for Google, that focus will be on its earnings per share. Based on the GAAP accounting standards, net income for the quarter was $1.84 billion, up from $1.48 billion last year. Analysts evaluate company earnings by excluding certain expenses, like stock-option costs, and by those metrics Google's net income was $2.08 billion, up from $1.71 billion last year.That translates to earnings per share of $6.45 when you exclude those special items, and the financial community was looking for $6.52.

• ads that run on Google's own sites
• ads that run on Google's network -- all the sites that partner with the company and show its ads
• everything else Google does

The problem with growing that segment is that Google reports gross revenue without explicitly deducting the traffic acquisition costs, or the large chunk that the company must pay to its partners. Network revenue keeps floating just above 30 percent of total revenue, but a large portion goes out the door to others.

[Update: According to a Seeking Alpha transcript of the earnings call, traffic acquisition costs at $1.7 billion were 26 percent of the total ad revenue, or about 81 percent of the ad network revenue.]

The third category -- everything else -- represents the company's attempt to diversity, its future. That's the smallest and actually shrank as a portion of overall revenue, probably due to dropping efforts on the Google-branded Nexus One smartphone. Here's a graph that shows the revenue breakout by quarter since 2008:

The attempt to diversify has slackened some since last quarter, and given the end of selling the Nexus One, I would expect the percentage to drop even more by the next earnings report. Ad sales have grown, but the pace is slowing and the split between Google and network ads remains pretty stable. Google certainly has continued to roll out products and refinements of its foundation of ad systems, but looking at the basic metrics of where it gets its revenue, there's a sense of strategic stagnation. If it weren't for 2009 being such a bad year, relative growth would have been far more moderate. All this raises the question of whether Google is a company for whom luck has been a significant factor. If the Fickle Lady doesn't continue to bless management there, will the future be more of the same we see now?

Related:

• Google Diversifies; Non-Ad Revenue Grows 3X Faster than Ads
• Google Earnings Up, Revenues Stuck in Advertising
• Google Says Whew! and Pulls the China Gun Away from Its Head
• Google's Plans to TiVo YouTube Ads May Be Sign of Paid Subscriptions
• Google Unleashes Its Android App Zombie Army Strategy