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Tech Stocks Spanked for Google, Microsoft's Shortfall

Shares ofGoogleand Microsoftfell Friday after the latest earnings reports from the two tech giants cast doubts on the assumption that the two companies are immune to the recent economic downturn.

"Google was claiming to be immune to an economic slowdown - and the most interesting take away from last night’s report is that [Google] finally admitted that the consumer slowdown will impact their business," Clayton Moran, a media and communications analyst from Stanford Group, told CNBC.

"Now we’re seeing a broadening of the advertising slowdown and a lot of fears that it will be prolonged," Moran said. "And if Google’s going to be impacted, then that impact will last as long as the slowdown lasts."

(For more from Moran, see the video below.)

This is enough to unnerve already jittery investors.

Google shares fell $41.88, or 7.8 percent, in early morning trading, pushing Google's stock price below $500 for the first time in three months. Other tech stocks, including Microsoft were also trading lower.

Late Thursday, Microsoft reported earnings of 46 cents a share and revenue of $15.84 billion. Wall Street was for looking for earnings of 47 cents and revenue of $15.65 billion.

The results prompted Lehman to cut its price target on Microsoft to $32 from $34, but it maintained its equal-weight rating on the Dow component.

"We believe peaking product cycles such as Office 2007 and Windows Vista, an accelerating investment cycle to support the struggling Online Services Business and uncertainties surrounding Yahoo will remain an impediment to material multiple expansion in the near term," the firm wrote.

Red Flags at Google

The red flags raised Thursday by Google included a dramatic slowdown in the company's hiring pace and Chairman Eric Schmidt's description of the economy as "challenging." Google's chief economist, Hal Varian, even participated in the company's conference call for the first time to discuss business conditions.

"That was a tip-off," said Cantor Fitzgerald analyst Derek Brown. "Economic sluggishness has entered the discussion at Google, more so than we have ever heard."

Google earned $1.25 billion, or $3.92 per share, during the three months ended in June. That represented a 35 percent increase from net income of $925 million, or $2.93 per share, at the same time last year.

If not for costs incurred for employee stock compensation, Google said it would have earned $4.63 per share. That figure missed the average earnings estimate of $4.74 per share among analysts surveyed by Thomson Financial.

Google's second-quarter revenue fared slightly better than earnings, rising 39 percent to $5.37 billion from $3.87 billion at the same time last year.

More than half the revenue -- $2.8 billion -- came from international markets, helping to offset some of the economic weakness in the United States.

After subtracting commissions paid to its ad partners, Google's revenue totaled $3.9 billion -- about $30 million above the average analyst estimate.

Stanford Group analyst Clayton Moran interpreted the performance as "confirmation that there is a slowdown in Internet advertising that's affecting Google."

The trouble may stem more from reluctant consumers than advertisers.

The number of paid clicks on the Web sites operated by Google and its partners during the second quarter fell 1 percent from the first quarter, the first sequential downturn that the company has ever reported in the category. The 19 percent year-over-year increase in Google's paid clicks also was the company's lowest ever.

"Consumers are being cautious in their online spending patterns, just as they are in their off-line spending patterns," Varian told analysts during Thursday's conference call.

Trouble for Yahoo?

Google's second-quarter showing could foreshadow more difficulty for rival Yahoo when it releases its results for the same period next Tuesday.

After years of earnings disappointments, Yahoo needs to post good numbers and offer an upbeat outlook to reassure its shareholders as it tries to fend off a rebellion led by activist investor Carl Icahn. A rocky quarter would give Icahn more fodder in his effort to oust Yahoo's board at the company's Aug. 1 annual meeting so he can sell all or part of Yahoo to Microsoft Corp.

A big part of Google's earnings letdown had nothing to do with online ads.

Microsoft
Microsoft

After paying $3.2 billion to buy ad service DoubleClick in March, Google had less cash in the bank and was receiving less income on its remaining money because of lower interest rates.

Those factors produced just $58 million in interest and other income in the second quarter, down from $137 million a year ago.

"We continue to believe we are very well positioned," Schmidt assured analysts.

Varian told analysts the company might even benefit from a "Wal-Mart effect" if rising energy and food costs prod budget-conscious consumers to search for deals more frequently online.

Long known for its free spending ways, Google appears to be watching its budget more carefully too. The company added just 448 employees during the second quarter -- the fewest hired since the fourth quarter of 2004 when it ushered in 353 new workers.

Since 2004 Google has been hiring an average of nearly 1,200 workers per quarter to expand its payroll to 19,604 employees.

-AP contributed to this report.