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Is Google Inc (GOOG) Spreading Itself Too Thin?

Google Inc (NASDAQ:GOOG) reported yesterday that Q3 earnings missed EPS expectations by over 15%. Google cites a slowing in core business revenues as a key reason, as well as another disappointing quarter by Motorola Mobility. Yet, we believe that Google has no one to blame but itself for the stock’s near-11% decline since the earnings miss. Google has neglected its core business by trying to compete with the likes of Apple Inc (NASDAQ:AAPL), Microsoft Corporation (NASDAQ:MSFT), Facebook Inc (NASDAQ:FB) and Inc (NASDAQ:AMZN) on every facet, including mobile phones, tablets, social networks and streaming music.

Google Inc (NASDAQ:GOOG)

In the misshapen early release of Google’s 3Q results, the company reported EPS of $9.03 versus expectations of $10.65, missing estimates by more than 15%. Google Inc (NASDAQ:GOOG) is losing efficiency in the monetization of its advertising campaigns; cost-per-click revenues in the quarter were down 15% versus the same time last year, and average click revenues have been in decline for the past year. The other part of the blame was put on Motorola Mobility’s continued poor performance since being acquired earlier this year. That segment posted net income of $3 billion versus 2011’s total of $3.18 billion.

While Google Inc. (NASDAQ:GOOG) is getting into the hardware business and investing in private companies with its venture fund, Google Ventures, the company’s core market, advertising, is booming, but we believe this is where it has lost focus. In the first half of 2012, market-wide Internet advertising was up to $17 billion, a 14% increase year over year. Mobile advertising is seeing significant growth as well, up 95% year over year to $1.2 billion.

The online advertising industry is expected to continue to see very positive trends in the coming years, as company budgets are refocused to the Internet, versus traditional media. Total U.S. online advertising revenues are expected to be up 12% in 2012 and 10% in 2013, according to S&P. This is being driven by technology, including smartphones and tablets.

We understand Google Inc (NASDAQ:GOOG)’s need to stay relevant in mobile, as more and more searches are conducted via mobile devices, yet the purchase of Motorola has proven to be a drag on the company, and we can’t help but question its validity. We can also somewhat understand its venture into social networking with Google+, as peers are competing with Google Inc. (NASDAQ:GOOG) for advertising dollars, yet we still see poor execution as the root of all evil. While primary competitor Facebook sees its users online for an average of 7.5 hours a month, Google+ users are online just 3.3 minutes a month, a staggering difference.

Granted, some of Google’s margin compression can be attributed to its efforts to hire new employees for the Motorola integration, and to expand mobile search, which is a positive. The company will also have to address margin compression in the interim, as mobile search queries carry lower click rates and more tech platforms spread Google’s attention even thinner.

Google Inc (NASDAQ:GOOG) has spent a sizable amount of money of late on R&D and expansion efforts. In 2011, the company spent 14% of revenues on R&D and acquired Motorola Mobility for over $12 billion this year. The company now faces challenges and capital spending to integrate the Motorola deal. Google’s culture is centered on a Silicon Valley atmosphere primarily made up of software engineers, while Motorola is strictly hardware-focused and based mainly in the Midwest.

We believe that if the company can renew its focus on core search and expand mobile advertising, while avoiding the temptation to jump into hot markets that are non-essential to their operations, Google Inc (NASDAQ:GOOG) can easily get back on track. The company already owns 66% of the search engine market share and is now the dominant force in mobile, with around 500 million Android devices already activated and a current daily activation rate of around 1.3 million. Credit Suisse estimates that the core search business of Google Inc. (NASDAQ:GOOG) could grow at mid-to-high teens over the next five years.

Compared to the other big name companies that Google Inc (NASDAQ:GOOG) competes with, the stock now trades at an intriguing valuation. Google trades around 20x earnings, while its Chinese search engine peer, Baidu, trades around 30x. Microsoft, coming out of its last quarter earnings release, saw a drop in EPS of 20%, yet still has what we believe are key growth drivers moving forward, including Windows 8 and its new Surface tablet.

Apple continues to grow at impressive rates. The company recently launched its new iPhone, the iPhone 5, and is expected to grow this quarter EPS by 25%. Even though the company is up over 50% year to date, it still trades at only 15x earnings, yet is expected to grow EPS at a 23% CAGR over the next five years. While we like Google Inc (NASDAQ:GOOG)’s potential prospects, we also believe that Microsoft is flying under the radar with key initiatives and products that could help the company outperform. The same goes for Apple, yet we believe one key risk is continued innovation without Steve Jobs.

Amazon has one of the richest valuations of the bunch, trading at a P/E of 300.0X. Although Amazon has some of the best growth prospects, and is expected to grow EPS at a 35% CAGR over the next five years, we see the company’s forward P/E of 100.0X is still too rich. Also, even as Facebook is down over 50% since its IPO, the company still trades greater than 60x earnings. We would be hard-pressed to recommend either stock, Amazon or Facebook, given their valuations. At the time being, Apple and Google Inc (NASDAQ:GOOG) look like the best bets out of the bunch, with the former sporting slightly more attractive growth prospects and valuation metrics.

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