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Google: Slowing Growth, Higher Expenses No Cause for Alarm

Despite higher R&D costs at the wide-moat firm, we’re maintaining our fair value estimate, says Morningstar's Rick Summer.

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 Google's (GOOG) (GOOGL) third-quarter results showed robust demand by digital advertisers as the firm's growth continues to outpace the market. Despite higher-than-expected operating expenses (particularly research and development), we did not see anything in the quarter that would cause a structural change in our financial model. We are sticking with our $545 fair value estimate and our wide moat rating.

Overall revenue excluding traffic acquisition costs (excluding payments made to partners) grew 25% versus 2013, a slight deceleration from last quarter but still faster than rates the firm was posting in 2012. Google showed particular strength in its websites segment (which includes the core search business and YouTube, among other owned and operated websites), posting 23% growth, faster than our estimate for overall market growth in the midteens. We are modeling for continued deceleration as the industry and company go through a normal maturation cycle.

On the expense side, several items led to a dramatic uptick in costs, although we expect revenue growth to outpace these expenses in the coming quarters. In particular, management pointed to a third-quarter hiring cycle for new college graduates as well as annual equity compensations "refreshes" driving research and development to 16.1% of quarterly revenue, a 210-basis-point increase from the prior quarter and a 260-basis-point increase over 2013. The company remains in a heavy investment period, investing beyond its core business in areas such as cloud computing, YouTube, and a recently relaunched Google Express same-day delivery service.

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Rick Summer does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.