Why Google has underperformed? $GOOG

Google's business segments are divided into two: Google Service & Cloud.

First, let's talk about Google service. This part of the business is cyclical. We can call Google the barometer of the economy. If the economy is doing well, small & medium sized business (SMBs) will likely boost up their Ads spending hence Google's search business benefits directly. Google grew its revenue by 42% in 2021, way above its historic average of 20% simply due to COVID recovery, Fiscal support and Fed printing money. Since Q2 of 2022, Fed started tightening monetary by raising rate, the Ads business started deteriorating and the weakness continue into Q4 of 2022. There are signs of stabilizing but no signs of improvement of sentiment from advertisers.

Next is its Cloud business. Similar to Ads business, cloud services is also cyclical. For the same reason that SMBs cut their Ads spending, when belts are tight, SMBs cut their cloud spending as well. And it's not the Google's problem, AMZN and MSFT's cloud revenue also showed slower growth in recent quarters. We should expect growth of Cloud service reaccelerate once the overall economy rebounds. Google's cloud business grew 33% YoY and managed to shrink its operating loss by 36% which is on the profitable path.

So it seems like both Google and Meta are impacted by macro headwinds that dragged down its revenue growth, but why google underperformed? If we look at Q4 earnings report (chart below), Google grew its number of employees by an outrageous 21.4% in ONE year only! If a company grew its revenue by 10% and its employee count by 21%, that usually translates to an operating deleverage, meaning it's operating margin deteriorates. That sounds familiar, right? Meta had the exact same problem in its Q3 earnings, Operating margin dropped from 40% to 20% in a few quarters time. And its stock price dropped 25% on the day of its earnings. But ever since, Meta started cutting its work force fiercely and guess what, investor rewarded management's action by bidding the stock up by 100% in a matter of 3 month time.

By now, we should all realize that Google's problem is not unique, most tech companies gained too much fat (employee counts) post COVID due to macro tailwinds. Now that the tide is gone, they need to cut the extra fat that they gained in the last year or two in order to reaccelerate their operating margin. Meta and NFLX are great examples of taking the pill (to cut fat) and earnings back their investors’ trust. The bottom line is if macro headwinds persists longer than most anticipated, Goolge's recent 12,000 cut is probably not enough. Remember, the big Techs are all cash cows, the more cut they do, the more cash they return to their investors, and in the meantime, better margins and better profitability.

Disclosure: The author does not own GOOG at the time of this writing and this is not financial advice