Two roads diverge in a wood, and I took the one less traveled by, and that has made all the difference. – Robert Frost
Today’s market action after Yahoo’s second-quarter results may look like the garden-variety estimates game, but I detect a more profound shift. I think expectations of Google and Yahoo are diverging, as investors realize that Google has the better growth and profitability story.
After a nice spurt in regular trading today, both Google and Yahoo got hit in after-hours trading when Yahoo released their second-quarter results (listen to a podcast of the analyst call courtesy earningscast). But Yahoo suffered deeper wounds while Google was largely spared. Yahoo was off 10% after hours and down over 7% on the day, while Google was off 2% after hours but still up marginally on the day.
Given that Yahoo’s results were generally in-line with published analyst estimates, what gives? And since Yahoo was seen as a harbinger for Google, why didn’t Google get punished as well?
The easy answer (and the one you’ll see in the mass media) is that investors were expecting Yahoo to beat expectations. In other words, the published analyst estimates didn’t really reflect their genuine expectations. Yahoo’s 13 cents per share, which matched published estimates, failed to meet the “whisper number” (free reg req’d) of 15 cents per share.
The real reason that Yahoo was hit harder than Google may be that investors are seeing what I’ve been stressing for some time now – that Google is a breed apart from the internet crowd and is diverging to the upside from Yahoo and the others.
No question, Yahoo has a great business (I own shares in both Yahoo and Google). But next to Google, Yahoo looks like they’re standing still. Sure, Yahoo’s putting up growth and cash flow numbers that are the envy of most corporations. Yes, Yahoo is still innovating like crazy, they have a massive user base, and their revenues are much more diversified and predictable than Google. But they’ve become a stable, predictable, cash machine (not that there’s anything wrong with that). On the other hand, Google is still a wild growth company that repeatedly blows past even the most optimistic forecasts.
Google has managed to do the impossible – a billion-dollar enterprise with margins that are huge and getting wider, while growing at a torrid pace that is accelerating. Usually, large organizations (like Microsoft and increasingly Yahoo) can milk the cash cow and throw off lots of cash, but at the expense of growth. And usually, margins tend to shrink – not expand – as volume grows.
Let’s look at a few indicators. Yahoo is growing net revenue at the to-die-for rate of 44% year-over-year. That’s awesome until you look at Google’s 108% growth rate. Yahoo generates 46 cents in cash flow from operations for every one dollar in net revenue, which is an incredible margin – until you consider that Google is doing 67 cents per net-revenue dollar. Yahoo generates $417,000 in annualized net revenue per employee – which most CEOs would kill for – until you consider that Google’s employees are more than twice as productive at $912,000.
This is on top of an already-divergent market cap, with Google at about $86 billion and Yahoo at about $48 billion. If you recall, a year ago during Google’s IPO, Google priced at a significant discount to Yahoo. So the divergence has been in the works for some time now, but I’m betting that the gap will widen from here, favoring Google.
For my money, I’m hoping that Google delivers an in-line quarter on Thursday like Yahoo did today, and also suffers a 10% hit. If this happens, I’ll pick up more shares at ~270 because I believe that Google has taken the road less traveled and truly is a different breed.