Google: Growth stock at a value price
Analysts say shares of the search giant are undervalued, given its track record and growth prospects.
By Jake Lynch, TheStreet
The Internet search stalwart dominates the Web and offers international exposure. It also has an ample balance sheet, with nearly $32 billion of net cash. Most U.S. investors are familiar with Google's business model, its iconic co-founders Larry Page and Sergey Brin, and its penchant for innovation. However, few appreciate the company's overseas growth potential.
Google stock has risen 3.3% during the past 12 months even as sales have advanced 23% and earnings 30%. Similarly, in three years, Google's stock has delivered an annualized return of 8.3%, lagging sales growth of 21% and profit gains of 26%. Google's trailing price-to-earnings ratio, at 23, represents a 30% discount to its five-year average multiple.
If you expect Google to maintain its double-digit growth rate over the longer term, its stock offers an outstanding value. Of the 43 analysts who follow the company, 35, or 81%, rate the stock "buy," while eight recommend holding it. None advise clients to sell shares. That makes Google the 14th-highest-rated S&P 500 ($INX) stock and the second-highest-rated tech component, behind Apple (AAPL).
Google trades at a forward earnings multiple of 15, a book value multiple of 4.1 and a cash flow multiple of 17, 55%, 49% and 54% discounts to Internet software and services industry averages. Its PEG ratio, calculated by dividing the trailing P/E by analysts' terminal growth forecast, at 0.7, signals a 30% discount to estimated fair value.
Goldman Sachs (GS), which rates Google's stock "buy," says investors are overly focused on the company's domestic business. Google retained its 65% U.S. search market share in February and posted an outstanding 97% market share in the mobile search market. Its "explicit core searches," which reflect user engagement, increased 6.7% in February from a year earlier.
Goldman believes the rise of international search, as a percentage of global gross domestic product, is Google's best growth opportunity in the next decade. Search represents 13 basis points of GDP in developed markets, compared with four basis points in the rest of the world. Google will expand its core business as technology booms overseas.
Goldman forecasts 15% to 25% revenue growth over a three- to five-year span, with international desktop search comprising the largest portion. However, Google may need to ramp up sales and marketing efforts overseas to compete with local search rivals for advertisers. Goldman has an aggressive $720 six-month price target on Google, implying the stock might appreciate 23% before the end of 2011. That target is equivalent to nearly 21-times estimated 2011 earnings and 18-times 2012 earnings. Goldman views low search penetration relative to GDP as a reliable measure of potential, citing China and Russia, where ad spending is growing 90% and 40%, respectively.
The limited size of emerging markets and increasing competition from social networks may pose risks to Goldman's thesis. It's also possible, though unlikely, that developing markets will continue to favor traditional forms of communication for advertising. The growth of online advertising in the U.S. has largely been an offshoot of marketing firms' insistence that companies devote a greater proportion of spending to the Web. This trend may not materialize at a similar pace in developing markets, perhaps hurting growth.
Google's fourth-quarter adjusted earnings advanced 27% to $8.75, beating analysts' consensus estimate by 8.3%. Sales grew 26% to $6.4 billion, exceeding consensus by 5.1%. International revenue climbed to $4.4 billion, comprising 52% of net sales, helped by favorable currency exchanges. For 2010, Google derived 48% of its sales from the U.S., 11% from the U.K. and 41% from the rest of world. However, 86% of its long-term assets are U.S.-focused. As Google expands worldwide, that number will decrease. Google's quarterly gross margin remained steady at 69%. Its operating margin shrank from 37% to 35%.
Return on equity, the key profitability metric for stockholders, hovered above 18%, trailing the industry average of 19%, but beating the S&P 500 average of less than 13%.
The combination of value and performance should provide bullish conditions for Google's stock for the rest of 2011. Morgan Stanley (MS) now considers Google a Best Idea, one of nine U.S. stocks the bank believes offer the best risk/reward proposition, expecting the stock to rise 28% to $750.
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