Google: Too legit to quit
With Google set to be added to the benchmark S&P 500 index, some analysts think investors can now feel more confident about the company's prospects.
NEW YORK (CNNMoney.com) – It's official. Google really does matter.
Last week, Standard & Poor's said it was adding Google (Research) to its benchmark S&P 500 index after the close of trading on March 31. And the news couldn't have come at a more opportune time for the company.
Prior to the Standard & Poor's announcement, Google's stock had plunged 21 percent since Jan. 31 due to concerns about slowing growth following Google's first earnings miss and a series of high-profile communications blunders made by management.
But the stock has bounced back in recent days, gaining nearly 10 percent on the S&P 500 news. So is the worst over for Google investors?
Stocks typically enjoy a short-term pop when they are added to the S&P 500 since portfolio managers who run funds that mimic the index have to buy shares.
Because of this, several analysts said they expect Google's stock to rise further in the next few days.
"There is a wide range of funds that are benchmarked, and to some extent constrained to only owning S&P 500 stocks. So for Google, the universe of possible investors just expanded," said David Garrity, director of research with Hapoalim Securities.
In Google we trust
Inclusion in Wall Street's most prominent index of large-cap stocks also could help restore investors' faith in Google.
Investors are still smarting from vague comments made in February by Google chief financial officer George Reyes about slowing growth prospects.
To make matters worse, Google then messed up its Analyst Day Webcast by mistakenly putting up slides that detailed the company's internal sales targets. Google has famously refused to give public financial guidance so the gaffe was an embarrassing slip up.
Now that Google is in the S&P 500, an index that so many investors follow, Mark Stahlman, an analyst with Caris & Co., thinks Google will take greater care to avoid similar mistakes.
"Google has been taking actions to become more consistent and professional with the way they deal with the Street." Stahlman said. "And if you can tie anything to the inclusion of Google in the S&P 500, it's the recognition that Google is an important public company and they will probably need to act accordingly."
Sasa Zorovic, an analyst with Oppenheimer, agreed that Google's addition to the index should be a good thing for investors since the company and its executives, already heavily scrutinized, will now have even more attention paid to what they say and do.
"There will be a psychological boost," said Zorovic. "Google realizes they have done a bit of damage to themselves and they are examining how to communicate better. They will probably not make any more bungled announcements."
Still, Garrity said that once the stock is actually added to the index, the short-term euphoria may fade a bit. "Google being added to the S&P 500 is an important step forward. But perhaps it will be difficult to top at this time," he said.
Fundamentals getting stronger. How about investors' stomachs?
As such, what happens with Google's stock after most index managers buy it will depend more on how strong Google's first-quarter results are. There is no question that Google will deliver healthy growth when it releases its numbers sometime in April.
Analysts expect the company to report revenue, excluding ad sales it shares with affiliate partners, a figure known as traffic acquisition costs or TAC, of $1.45 billion, an 82 percent increase from a year ago.
And Wall Street is predicting that Google will report earnings per share of $1.99, an increase of 54 percent from the same period last year.
Zorovic said he's confident Google's stock will bounce back after it reports first-quarter numbers. Investors may be wary of the stock before the results because they are still licking their wounds following Google's earnings miss in January.
But Zorovic said that based on conversations he's had with several marketing agencies that place ads on Google, Yahoo! (Research), Microsoft's (Research) MSN and other search engines, he thinks demand for online search ads has increased during the past few months.
"Search engine marketing firms sound more bullish now than they were in January. When Google reports its March quarter numbers, sentiment will start to turn. Momentum is better now," he said.
With that in mind, Stahlman thinks that now is a good time for investors to get back into Google since many short-term oriented investors have already bailed. The stock, while still not a bargain, now trades at about 40 times 2006 earnings estimates, much cheaper than where it was before it reported fourth-quarter results.
"Google's business is strengthening and the company is continuing to take share from competitors," Stahlman said. "The sell-off is clearly a rotation of ownership. This is a classic opportunity for people who didn't want to compete against aggressive momentum investors to take a more careful look. That's exactly what's happening."
Martin Pyykkonen, an analyst with Hoefer & Arnett, agreed that Google now appears to be attracting a steadier, less trigger-happy group of longer-term oriented investors. And the addition to the S&P 500 just gives Google an even wider base of buy-and-hold institutional owners.
He added that if Google can prove that the fourth-quarter earnings miss was an anomaly, institutions won't be as likely to sell following the next earnings news.
"The S&P 500 addition should give Google more stability and the stock won't be as volatile as it has been for the past year," Pyykkonen said.
"As long as Google reports a decent quarter with no red flags and shows more revenue diversification, then more institutional investors will realize it should be a fundamental core holding and not as much a trade in and out of type of stock," he said.
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