Smartphone ad growth slams Google's margins hard

07/18/2013 7:50 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The first of today’s two big, after-the-close earnings misses: For its second quarter Google (GOOG) reported earnings of $9.56 a share, a huge $1.24 a share below Wall Street consensus. Revenue climbed 18.6% from the second quarter of 2012 to $14.11 billion. That too missed the Wall Street consensus but by a much smaller margin. Analysts had been expecting revenue of 14.46 billion.

Google’s miss seems to be a margin problem. In the second quarter of 2012 GAAP operating income was 27% of revenue. In the just completed quarter operating income was only 22% of revenue. On a non-GAAP basis operating income fell from 33% of revenue to 28% in the second quarter of 2013.

And it’s not hard to find the culprit. The average cost-per-click, what Google collects from advertisers when a user clicks on an ad served on a Google site or on the site of a network member, fell 6% from the second quarter of 2012 and dropped 2% from the first quarter of 2013. Wall Street analysts were looking for a 3% year-over-year drop in cost-per-click.

The cause of the drop was the same problem that has plagued Google and other online advertising sites such as Yahoo (YHOO) for quarters.As consumers increasingly use smart phones instead of desktop computers to access the Internet, Google is seeing the percentage of ad sales that come from mobile phones rise. And the average smartphone-based ad sells for 40% less than a comparable desktop ad, according to Covario.

It didn’t help Google’s earnings either than its Motorola Mobility smartphone hardware unit saw its GAAP operating loss climb to $342 million in the quarter from $199 million in the second quarter of 2012.

But Google’s Motorola hardware business isn’t the heart of the search company. Advertising is. And it's the worryingly lower results from the ad business that sent Google shares down to $858.80 in afterhours trading after the stock closed the regular trading session at $910.68.

Tomorrow we’ll get to see how much of a market bellwether Google is. I’d expect profit-taking on a Friday anyway after a week of gains. Google’s results might emphasize that trend.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , I liquidated all my individual stock holdings and put the money into the fund. The fund did not own shares of any stock mentioned in this post as of the end of March. For a full list of the stocks in the fund as of the end of March see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/

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