Google (GOOGL) posted strong second-quarter results, demonstrating robust demand in its core business and stronger expense discipline. We continue to believe the shares are undervalued, even after the strong move after results were announced.
Investors should focus on the long-term growth potential of the firm
We are sticking with our wide moat rating and $715 fair value estimate at this time.
Total revenue grew 11%, 18% on a constant currency basis, to $17.7 billion, while revenue excluding traffic acquisition costs grew more than 13%, as the firm realised strong top-line growth even as it de-emphasized payments to distribution partners, including Mozilla as a premier search provider.
As users migrate to mobile devices, where they can choose to use applications as opposed to browsers and search, Google's results demonstrate the importance of Internet search in the overall advertising value proposition, in our view. The significance of Internet search and Google's wide moat in the online advertising sector remain key inputs to our investment thesis.
Our model assumes meaningful operating margin expansion over the intermediate term, and the quarter delivered on that front as well. GAAP operating margins expanded 50 basis points versus 2014 and 140 basis points sequentially, to 27.2%, benefiting partially from lower legal expenses as well as modest sales and marketing leverage. Although we expect reasonable noise around operating margins from quarter to quarter, we forecast continued operating margin expansion over the next several years.
Management pointed to a more measured approach to capital expenditures in the near term as the company digests a period of heavy investment. Free cash flows, defined as operating cash flow less capital expenditures, grew nearly 50% versus 2014.
We do not expect massive increases in capital expenditures going forward. We are encouraged by the quarterly results and suggest that investors focus on the long-term growth potential of the firm and the potential for profits to outgrow revenue for the foreseeable future.