Google posted second-quarter financial results that were modestly below forecasts for both revenues and earnings. The share price was beginning to bake in some overly optimistic expectations and it is no surprise that the market paused following the results. Given the relatively conservative view and after comparing our long-term discounted cash flow model to the quarterly financials, analysts do not expect a material change to the fair value estimate (currently at $770) and consider the shares to be modestly overvalued.

Revenues grew 20% year over year to $10 billion excluding payments to advertising partners (TAC), slightly below the full-year forecast of 21%. Advertising revenues, excluding TAC, rose 14% as TAC payments were higher than most projections. Notably, advertising revenues excluding TAC for Google’s online advertising network (ads placed on sites not owned by Google) did not grow at all.  Google’s high historical growth rates and future increases in advertising payments to partners are likely to make future comparisons more challenging.

As a case in point, non-GAAP operating margins came in at 28.3% for the quarter, down 500 basis points year over year. No double-digit growth in operating income is expected over the next five years, and many  have become incrementally more cautious lately about Google’s stock price (which had been up 28% year-to-date, outperforming the NASDAQ by 900 basis points). Still, there is nothing in the quarter to cause us alarm regarding the company’s wide moat or overall demand for Google’s advertising platform.

Many people continue to believe that Google has the widest moat in the Internet advertising sector, and the company typically represents a core holding for many investors. We also expect the global Internet advertising market will grow in the low to mid-teens over the next three to five years, and Google is not likely to lose meaningful market share.

Still, we remain sensitive to valuation and caution that Google’s future growth will come from less profitable products that require higher revenue sharing with partners and costs from delivering hardware devices. We believe the shares do not provide an appropriate margin of safety, and we do not expect the stock to deliver excess returns at this time.