For all its jazzy investments in space travel and genetics, Google Inc. remains a one-trick pony. Search advertising provides nearly all of the Internet company’s profits. Now that the economy is slowing, the question is whether this impressive engine—which has yet to be tested in a recession—will sputter. The precipitous decline in Yahoo Inc.’s stock in 2000 provides some clues to Google’s prognosis.
Like Google, Yahoo was the Internet juggernaut of its day. Similarly, it depended on advertising, which is highly cyclical, for most of its profits. Moreover, Yahoo’s stock began to fall nearly a year before a recession started and revenue growth tumbled. The stock didn’t reach a bottom until September 2001. Google shares have fallen by more than a quarter from their November high, even though a recession has yet to officially start.
Could Google follow its predecessor and see its $172 billion (Rs6.77 trillion) market capitalization fall 97% from its peak, as Yahoo did? It’s unlikely Google will fall to $22 a share—Yahoo traded at more than 600 times estimated earnings at its apex. Google now trades at a more reasonable 29 times. Crunch the numbers, and investors look to be expecting Google’s earnings to grow about 12% faster than the market as a whole for the next five years—not outrageous considering earnings did rise more than 40% in the last quarter.
Moreover, their businesses have a fundamental difference. Google’s search ads tend to be more efficient as advertisers pay when viewers click through to them. Because clients can track their return on the marketing investment, which tends to be higher than other sorts of advertising, the theory is Google’s search business may be more sheltered from economic storms than the display ads where Yahoo is a leader.
This doesn’t mean comparing Google with Yahoo is bunk, merely overdramatic. In a hard recession, troubled companies cut back on advertising regardless of efficacy. Consumers and businesses will buy less stuff, which means they will click on fewer ads. And just as Yahoo was hurt by the dotcom advertising bubble imploding, the housing and mortgage crises will hit Google.
This hasn’t happened yet. Troubled lenders such as Countrywide are engaged in furious marketing blitzes to survive and catch a mini refinancing wave sparked by interest rate cuts. Other sectors have yet to show signs of reduced ad spending. But the impact of a true recession will change that — and almost certainly take a bite out of Google’s earnings and its giant market cap.