Google's Profit and Sales Leap, Firing a Rally

Google has defied the skeptics. The Web search leader reported third-quarter earnings that far exceeded the expectations of analysts, especially those who thought the company might finally fall victim to the slumping economy. Thanks largely to having contained costs better than in previous quarters, Google reported on Oct. 16 that profit rose 26%, to $1.35 billion, significantly higher than analysts had predicted. Sales jumped 31%, to $5.54 billion.

Relieved investors propelled the stock higher by as much as 10% after the results were released. The rally followed a 4% gain, to 353.02, which mirrored a broader market surge in regular trading. Until Oct. 16, Google's stock had plunged 53% this year.

In a conference call with analysts, Google (GOOG) executives sounded the familiar, confident notes of the past several quarters. "The economic situation today is globally worse than what people were predicting just a month ago," CEO Eric Schmidt said. "But we're optimistic about Google's future." The comments resembled those of about a month ago, when Schmidt said the "drama is in New York, not here," and "it's business as usual at Google."

Analysts Had Cut Targets

Schmidt's remarks—and the numbers that back them up—underscore Google's resilience, even as growth slows in overall online advertising. Search-related ads, which make up the bulk of Google's sales, appeal to advertisers because they reach customers ready to buy and because their results can be measured, analysts and Google executives say. "Advertisers are willing to take all the clicks we can give them" at current prices, Hal Varian, Google's chief economist, said during the conference call. A recession will prompt consumers to use search even more frequently to find deals, Varian said.

Google's profit per share, before stock option expenses, was $4.92—17 over expectations of $4.75. Net revenue of $4.04 billion, after payments to partners that run Google ads on their sites, was just a hair below the $4.06 billion expected by analysts. However, many analysts were informally assuming earnings might undershoot previous forecasts and have been reducing estimates and price targets in recent weeks.

Much of the earnings surprise came because Google slowed expense growth. The company hired 519 people in the quarter, compared with 2,130 a year earlier. It also reduced once-rampant capital spending by 18%, to $452 million. "Across all categories of expenses, people have been very diligent" in watching costs, Chief Financial Officer Patrick Pichette said. Rob Sanderson, an analyst with American Technology Research, said investors are relieved that Google is willing to keep a lid on expenses to buoy profit.

Online Advertising: Slowdown Evident

While growth in the U.S. continues at a respectable pace, some analysts saw cause for concern in Europe. Although most regions experienced "solid" growth, according to Pichette, revenue in Britain rose only 17% from a year earlier, compared with a 29% gain in the second quarter. "That is going to spread into Continental Europe," Sanderson says.

Google beat forecasts despite a negative impact from the strengthening dollar, which reduced effective earnings because of Google's significant international business, which accounted for 51% of sales. That's likely to continue into the fourth quarter and next year, even with a currency hedging program that began last quarter.