$400 GOOG too scary
The original search engine, Yahoo, is a more reasonable option for investors.
SAN FRANCISCO (FORTUNE) - Any discussion of investing in the new Net boom naturally begins with Google (Research). No one argues that Google, which will report earnings after the bell Thursday, isn't a fantastic business. The company is on track to earn $3.7 billion next year on sales of $9.5 billion. That's about nine times the profits and three times the revenues it had in 2004, the year it went public.
The company makes almost all its money from Internet search ads, and its U.S. market share is at 42 percent and growing. "We're in this amazing gold mine of search advertising," says Google CEO Eric Schmidt.
If Google's so good, it has to be a buy, right? Not necessarily. Google, the stock, has several things against it, starting with its high valuation and high expectations. The company's own chief financial officer has acknowledged that the law of big numbers--the added volume needed to make a big firm even bigger--will eventually slow Google down.
And the company's refusal to give detailed financial guidance to Wall Street has led to wild ups and downs. In 2006 alone, Google has traded as high as $475 and as low as $331, a swing of $43 billion in market value, or nearly what McDonald's is worth.
Says Arnold Berman, technology strategist for Cowen & Co.: "Each quarterly report is a massive nail biter from here out. It will be a back-and-forth stock for the rest of 2006."
The more reasonable option for value-conscious investors is Yahoo (Research), which reported earnings that matched investor expectations Tuesday. Very much a media company, where Google emphasizes its technology roots, Yahoo has similarly benefited from the tsunami of online advertising. But unlike Google, it has struggled in the lucrative search area--and that may provide the opportunity for investors.
If the company can improve in search (and it has a crack team working on the problem), the potential upside is dramatic. Especially considering Yahoo's price: It trades at 15 times its estimated 2006 earnings before interest, taxes, depreciation, and amortization, about two-thirds of Google's Ebitda multiple. That's the kind of valuation you would give a newspaper company, not a Net powerhouse, says UBS analyst Benjamin Schachter, who thinks Yahoo's shares--recently around $31--could hit $39 within the year.
(This is an excerpt from a story that ran in the May 1, 2006 issue of Fortune. To read the complete story, click here or go to www.fortune.com)