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A tale of two search engines
Yahoo! should report a great 2Q but investors only have eyes for Google. How long can that last?
July 15, 2005: 5:27 PM EDT
By Paul R. La Monica, CNN/Money senior writer
Go-go Google: Shares of Yahoo! have lagged its top rival this year.
Go-go Google: Shares of Yahoo! have lagged its top rival this year.
INVESTOR RESEARCH CENTER INVESTOR RESEARCH CENTER upgrades & downgrades earnings & warnings public offerings INVESTOR RESEARCH CENTER INVESTOR RESEARCH CENTER
Search is sexy
Yahoo! and Google should post phenomenal gains in sales and profits.
Company Q2 04 Sales  Q2 05 Sales* Q2 04 EPS Q2 05 EPS* 
Yahoo! $609 million $880 million $0.08 $0.13 
Google $423 million $841 million $0.58 $1.20 
 * based on estimates as of 7/15/05
 Source:  Thomson/Financial

NEW YORK (CNN/Money) – If Charles Dickens were alive today, he probably would begin a story about Google and Yahoo! like this:

It was the best of times; it was the best of times.

Both Internet media companies are flourishing thanks to healthy demand for online advertising, particularly sponsored ads tied to keyword searches. The two firms are both scheduled to report second-quarter results next week and the growth should be nothing short of spectacular.

Yahoo! will release its numbers Tuesday afternoon. Analysts expect revenue, excluding fees shared with affiliates, a figure known as traffic acquisition costs (TAC), to increase 45 percent while earnings per share will be up 63 percent from the same period a year ago.

Google's numbers come out on Thursday after the closing bell. Its revenues, excluding TAC, are predicted to nearly double and profits are expected to increase 107 percent.

Analysts expect both firms to report earnings gains of 30 percent a year, on average, for the next few years. So with that in mind, you would think that both stocks would be enjoying the love of Wall Street.

But that's not the case.

Googly-eyed

For some reason, as far as investors are concerned, there is only one search company worth paying attention to: Google.

Shares of Google (Research), which closed above $300 on Thursday, have surged more than 56 percent this year and have shot up more than 250 percent since the company's initial public offering last August. And analysts are falling over themselves to slap higher price targets on the stock.

Yahoo!'s stock, on the other hand, is down about 2 percent this year and has gained a little more than 30 percent since Google's IPO.

Will this last? Some analysts are starting to question how much longer Google can continue to outpace Yahoo! (Research)

Scott Kessler, an equity analyst with Standard & Poor's, said that there is far more pressure on Google to report better than anticipated results than there is on Yahoo! That's because Google has beaten consensus estimates by an average of 28 percent in its first three quarters as a public company.

"It's fair to say that Google wildly exceeded all analysts' estimates for the few quarters they have reported and people are looking for them to do that again," Kessler said. "There might be a situation where expectations are too high."

And since there isn't the same clamor for Yahoo! to crush estimates, it might be the better bet, heading into next week.

"From a short-term perspective, the market is expecting reasonable growth for Yahoo! so that makes it a safer stock to buy today," said David Edwards, an analyst with American Technology Research.

There's also the issue of valuation. Since Google went public, it has traded at a discount to Yahoo! on a price-to-earnings basis. It still does, but the gap has narrowed considerably. Google currently trades at 58 times 2005 earnings estimates compared to a P/E of 64 for Yahoo!

But if you compare the two based on earnings before interest, taxes, depreciation and amortization (EBITDA), a measure of profitability that analysts often use to look at media stocks, Google now fetches a higher valuation.

According to estimates from Philip Remek, a media analyst with Guzman & Co., Google trades at about 39 times EBITDA. Yahoo! has a multiple of 32. Some analysts question whether Google deserves this premium.

"Google has notably more risk in my opinion right now. Yahoo! offers a lot more upside," said Kessler.

Searching for stability

That's because Yahoo! is not a one-trick pony, analysts say. Sure, on the surface, Google and Yahoo! appear to be remarkably similar. Both have rolled out new features during the past few years, such as comparison shopping engines, local search tools and video search technology in order to attract more users and ad dollars.

But the firms actually have quite different business models. Google derives almost all of its revenues from paid search advertising. Yahoo! gets money from so-called branded ads, banners and pop-ups, in addition to search. The company also has businesses that generate steady fees, such as its HotJobs employment listing site.

"One weakness with Google is that it only has the one stream of revenue," said Remek.

"Yahoo! has a more diversified revenue stream so that would be a comparative advantage going forward."

Edwards agrees. He thinks Google is still a "must-own" stock for a longer-term oriented investor but that traders who have already made a significant profit in the stock would be wise to take some money off the table and put it into Yahoo!.

"I like Yahoo!'s diversification because it gives them multiple growth opportunities and more stability," he said.

Still, others say investors need to realize that both companies trade at extremely high valuations. And since it's not a secret that they are doing well, chasing either stock at their current levels could be dangerous.

"If I went and told my boss to buy something with over a 50 P/E, he'd kill me," quipped Ethan McAfee, director of research with Ramsey Asset Management, a McLean, Va.-based hedge fund that has no position in either stock. "Both companies are extraordinarily successful and have tons and tons of growth but the problem is everybody else realizes it."

For a look at more Internet stocks, click here.

Will Harry Potter lead to a magical ride for Amazon.com? Click here.

Analysts quoted in this story do not own shares of Google or Yahoo! and their firms do not have any investment banking relationships with either company.  Top of page

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