Google Inc. , once a favoured growth stock, now trades at a discount relative to peers, despite its steady expansion.
The Internet search stalwart dominates the web and offers international exposure. It also has an ample balance sheet, with nearly $32-billion (U.S.) 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 per cent during the past 12 months even as sales advanced 23 per cent and earnings climbed 30 per cent. Similarly, over a three-year span, Google's stock has delivered an annualized return of 8.3 per cent, lagging sales growth of 21 per cent and profit gains of 26 per cent. Google's trailing price-to-earnings ratio, at 23, represents a 30 per cent 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 per cent, 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 stock and the second highest-rated tech component, behind Apple . Google trades at a forward earnings multiple of 15, a book value multiple of 4.1 and a cash flow multiple of 17, 55 per cent, 49 per cent and 54 per cent 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 per cent discount to estimated fair value.
Goldman Sachs, which rates Google's stock "buy", says investors are overly focused on the company's domestic business. Google retained its 65 per cent U.S. search market share in February and posted an outstanding 97 per cent market share in the mobile search market. Its "explicit core searches", which reflect user engagement, increased 6.7 per cent in February from a year earlier.
Goldman believes international search's rise, 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 per cent to 25 per cent 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 per cent 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 per cent and 40 per cent, 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 favour 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 per cent to $8.75, beating analysts' consensus estimate by 8.3 per cent. Sales grew 26 per cent to $6.4-billion, exceeding consensus by 5.1 per cent. International revenue climbed to $4.4-billion, comprising 52 per cent of net sales, helped by favorable currency exchanges. For 2010, Google derived 48 per cent of its sales from the U.S., 11 per cent from the U.K. and 41 per cent from the rest of world. However, 86 per cent 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 per cent. Its operating margin shrank from 37 per cent to 35 per cent.
Return on equity, the key profitability metric for stockholders, hovered above 18 per cent, trailing the industry average of 19 per cent, but beating the S&P 500 average of less than 13 per cent.
The combination of value and performance should provide bullish conditions for Google's stock for the rest of 2011. Morgan Stanley now considers Google a Best Idea, one of nine U.S. stocks that the bank believes offer the best risk/reward proposition, expecting the stock to rise 28 per cent to $750.