Feeling lucky with Google
Stock Spotlight: Google has taken a tumble lately. Is it time to buy or search for the exits?
By Paul R. La Monica, CNNMoney.com senior writer

NEW YORK (CNNMoney.com) Google is a mere mortal after all. Prick the stock and it doth bleed.

Shares of the top search engine have fallen nearly 10 percent in the past week and a half. Of course, the stock, at a price of about $435 a share is still up more than 400 percent since its initial public offering.

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But there have been some cracks in the "Google can do no wrong" story lately.

Google's top rival, Yahoo!, reported fourth quarter results and 2006 guidance that failed to excite Wall Street, leading to concerns that Google's numbers could also miss targets. Two analysts downgraded Google (Research) to "sell" in the past week, citing valuation.

Some investors are worried about the potential impact of a recent squabble between the federal government and Google. The government has sought information from search engines as part of its attempts to reenact a law to protect minors from online pornography.

The Justice Department has said that several of Google's competitors have cooperated with its request for records. But Google has so far refused to hand over any information, citing privacy concerns. As a result, the Justice Department filed a motion in a U.S. District Court last week demanding that Google turn over random search results.

Finally, Google has also come under fire for launching a version of its site in China which allows the Chinese government to censor search results about topics such as human rights.

Still, with Google set to report its fourth-quarter results on January 31 and analysts expecting sales and earnings to nearly double, some think the pullback is a buying opportunity. Are you feeling lucky?

Believe the hype?

Investors appear to be worried that as goes Yahoo! (Research), so goes Google. And if Google stumbles and misses consensus estimates, it will be the first time in its short history as a public company that it has done so.

But even if Google doesn't miss, the pressure is on the company to do more than merely meet, or even slightly beat, forecasts. Google has trounced Wall Street's consensus earnings estimates by an average of 21.5 percent during its first five quarters as a public company.

"Expectations for GOOG are still quite high," wrote Rob Sanderson, an analyst with American Technology Research, in a note previewing the fourth-quarter results. "We believe upside to consensus estimates and upward revisions will be required for good stock performance following the report."

Analysts expect Google to report earnings of $1.76 a share, according to Thomson First Call, and sales, excluding advertising revenue shared with affiliates, a figure known as traffic acquisition costs (TAC), of $1.29 billion.

Since Google does not give guidance, it's even more important for the company to blow away estimates since doing so would allow analysts to boost their full-year 2006 targets...which could justify the stock's price.

To that end, Jefferies & Co. analyst Youssef Squali wrote in a note previewing Google's earnings that he expects to raise his 2006 estimates after Google reports.

Analysts currently expect Google to post an increase in sales, excluding TAC, of 63 percent this year, to $6.55 billion, and that earnings will soar nearly 50 percent to $8.76 a share.

Outclassing the competition

Internet investors seem to be exclusively Googly-eyed most other online stocks have underperformed the market for the past year. So it's tempting to think that Google must be overvalued.

To some, this rise brings back memories of the late 1990's dot-com mania. But given how rapidly Google is evolving, it's getting tougher to argue that the company is a flash in the pan benefiting merely from bubble mentality.

The knock on Google used to be that it relied solely on online search advertising. But Google, like the women in those bizarre Virginia Slims cigarette ads from the 1970s, has come a long way, baby.

It recently announced it was acquiring dMarc Broadcasting, a privately held firm that will give Google the ability to start placing radio ads. The company is also launching a service called Google Base, which should allow it to compete more effectively with the classifieds sections of newspapers.

And Google, like Yahoo! and Apple's iTunes, has even taken some steps to cash in on the growing demand for digital content. Earlier this month, Google unveiled an online video store where consumers can buy downloads of CBS TV shows and NBA basketball games.

All that adds up to a more diversified revenue stream...and that removes one of the biggest risks that many analysts thought Google faced shortly after its IPO.

Next stop...$500 or $300?

So what does this all mean for the stock? On a price-to-earnings basis, shares of Google, dare we say it, look attractive. The stock trades at about 49 times 2006 earnings estimates. While that's not cheap, it's not bubbilcious either, considering that earnings are expected to increase at a 30 percent clip, on average, for the next few years.

It's also a big discount to Yahoo!, which trades at 65 times this year's profit projections even though its long-term projected earnings growth rate of 26 percent is lower than Google's. Plus, analysts slashed their 2006 earnings estimate for Yahoo! by nearly 30 percent in the wake of its fourth-quarter miss.

Still, Stifel Nicolaus & Co. analyst Scott Devitt, one of the two who downgraded the stock to "sell," wrote in a recent report that due to many of the uncertainties surrounding Google, including legal concerns and increased competition from the likes of Yahoo!, Microsoft (Research) and others, it is "difficult to use any methodology to value Google's cash flow."

But another analyst has a different take on the government's subpoena of Google. Piper Jaffray analyst Safa Rashtchy, who believes Google's stock could hit $600 within a year, argued in a recent research note that Google's "principled stance" on privacy could make the company even more popular.

"Google continues to gain market share and its brand is getting stronger everyday. In our opinion, even if Google is forced to provide the information requested by the government, there will be no impact on Google's usage patterns," Rashtchy wrote.

So Rashtchy thinks the sell-off in Google was overdone. And we do too. Despite Yahoo!'s slip, Google deserves the benefit of the doubt. Sure, it probably will be a volatile stock for the foreseeable future but Google hasn't disappointed Wall Street yet and shows no signs of slowing down. And as long as earnings keep growing and the company keeps entering new businesses, it should continue to be a good stock for the long haul.

Google's new motto? Don't be unprofitable. Click here for more.

For a look at more Internet stocks, click here.


Piper Jaffray has done investment banking for Google but Rashtchy does not own the stock . The other analysts quoted in this story do not own shares of Google and their firms have no banking relationships with the company. Top of page

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