Why did investors freak out about Google?

Investors punished Google for the less-than-stellar second quarter results it reported on Thursday, sending the share price down about 10 percent to $482 in Friday trading. So what went wrong?

No one thing was responsible, but a few factors combined to make a 35 percent growth in net income to $1.25 billion look like bad news.

Interest income
First, the company missed expectations: net income, excluding various items, was $4.63 per share, short of the $4.74 expected by analysts surveyed by Thomson Reuters, and that's usually enough to send the stock down in after-hours trading.

Google revenue continued its upward trajectory in the second quarter, but not to the satisfaction of Wall Street. (Click image to see larger version.)

(Credit: Google)

But up at the top line, revenue was in line with expectations. One big reason the bottom line was at odds: interest income, the money Google earned off its cash pile, was lower than analysts had forecast. That income dropped to $58 million in the second quarter from $109 million in the first, a decline Google blamed on lower yields, a cash reserve shrunken somewhat by the DoubleClick acquisition, lower gains from sales of securities, and greater expenses hedging against foreign exchange rates.

Macroeconomic uncertainty
A second culprit is the slow economy. Google executives didn't come out and say they were hurt by slower ad spending, but they sounded more cautious overall than three months ago, when they all but said, "Economic slowdown? What slowdown?"

This time Chief Executive Eric Schmidt launched the call optimistically but with a note of warning: "Traffic and revenue have held up well despite uncertain economic conditions."

And Google brought chief economist Hal Varian onto the call to give some detail on the slowdown. Here's what he had to say about the situation in the United States: "The query growth has been positive in every sector we track, even including those sectors that are generally economically sensitive such as automotive, real estate, and travel. We also see that year-on-year revenue growth is positive in every major sector except for real estate, and even that one is only down by a small amount."

But it could be investors were spooked more than they should have been.

"While the company went to unusual lengths to highlight its relative strength in a weakening macro environment, we think simply by virtue of highlighting it, they may have created more confusion," said UBS analyst Benjamin Schachter in a research report Friday. "We continue to view Google's pay-for-performance model as somewhat resistant to an economic downturn (but not immune), and believe that the company could, in theory, even gain share during a downturn as advertisers look to consolidate ad dollars with a 'more measurable' solution."

Paid clicks
The third factor, though, was perhaps the most interesting, because it's the one that's under Google's control to an extent: paid clicks, which while increasing 19 percent from the second quarter of 2007 actually decreased 1 percent from the first quarter of 2008.

The vast majority of Google's revenue comes from selling ads that appear next to search results; the company is paid when searchers click on the ads, generating a paid click. Google tries to strike the right balance between showing low-grade ads on many search pages and high-quality ads on only a few. Erring on one side means that ads are often irrelevant to searchers or leave them dissatisfied when they click; erring on the other side means the ads are more valuable to searchers, helping to train people to pay attention to ads, but showing fewer ads means Google doesn't have has many opportunities to get paid.

"There is some evidence that I think we've been probably a little bit more aggressive in decreasing coverage than we ought to have been," co-founder Sergey Brin said.

Taking these factors together, some Wall Street analysts were less ruffled than investors.

There are favorable long-term trends that are grounds for Google optimism. "We continue to expect Google to gain search share and monetize newer initiatives such as YouTube and Google Apps over time. We are maintaining our 'outperform' rating," said Cowen analyst Jim Friedland, who also expects Google's search ad partnership with Yahoo to produce $100 million to $200 million in revenue in its first year of operation.

And Collins Stewart analyst Sandeep Aggarwal thinks the Google stock drop was out of line: "We believe post-earnings reaction was excessive and we would be buyers of Google on any weakness."

[Info_Max]

Google sales & shares went down because of Anoox that is revolutionizing the search engine business because of these reasons:
1- Anoox search results are powered by the people, that is YOU and ME, so they are democratically created based on wisdom of crowds which is only way to get best results
2- Anoox cost of Advertising is much lower because it is operated on a not-profit-motivated basis like Craigslist. OTN, our small business has saved like $10,000 over the last year since we switched our Advertising to Anoox. Now that is savings that is great for our business, but I am sure not great for Google's $100Bill valuation.

Silicon valley supposedly likes "Disruptive technologies", well few get more disruptive than Anoox.

[Info_Max]

Google sales & shares went down because of Anoox that is revolutionizing the search engine business because of these reasons:
1- Anoox search results are powered by the people, that is YOU and ME, so they are democratically created based on wisdom of crowds which is only way to get best results
2- Anoox cost of Advertising is much lower because it is operated on a not-profit-motivated basis like Craigslist. OTN, our small business has saved like $10,000 over the last year since we switched our Advertising to Anoox. Now that is savings that is great for our business, but I am sure not great for Google's $100Bill valuation.

Silicon valley supposedly likes "Disruptive technologies", well few get more disruptive than Anoox.

[coyote_ptm]

Posting ads on cnet is free - as you can tell from the previous two posts...

[AhoyWillem]

Hmmm - not-profit-motivated basis is right. Do a search on Anoox (what a stupid name to begin with) on something as basic and high profile as, say, Paul McCartney, and you get paid listings for chocolate chip cheesecake and credit cards.

Then the "people-powered" results start with paulmccartneytickets.com. followed by a string of Paul McCartney impersonators. Not one listing for the obvious first result - PaulMcCartney.com, or even mpl, his company or anything related to the Beatles.

Methinks Sir Paul could have a copyright infringement field day on unlicensed use of his name with these sites.

But what a pathetic bit of spamming.

As for Google, blame skittish, uninformed investors who always act like lemmings and do ignorant damage to company valuations. How many other companies do you know that can boast a 35% growth rate in NET income during these economic conditions.

It's time for CEO's like Schmidt to start showing some leadership and calling these ignoramuses (including tech and Wall St. media) on the carpet about uninformed and misinformed presumptions.

GET THE FACTS! And thanks to Stephen for setting the record straight with his great analysis!

[new_media_works]

I think that alot of people indeed may have sold because of the way that the earnings call was handled (quite poorly -- questions were avoided and there was even some "waffling").

See my post about this: Eric, economic weakness: are you seeing things deteriorate a little bit further?