Is Google Expensive?

Includes: AABA, GOOG, MSFT
by: Mark Krieger

Expensive is a relative term. Those on the short side would say Google (NASDAQ:GOOG) is expensive while those holding long positions would probably argue the contrary.

The fact is, GOOG has been on quite a run lately as analysts keep piling on with continual sweetening views. The trouble is, this could be a disservice to longs as these increased expectations increase the possibility of an eventual disappointment. The problem is the law of bigger numbers: each time GOOG reports it is dealing with a larger comparison number from the previous year’s period. This increase in the denominator makes growth increases more difficult.

GOOG is expected to report third quarter earnings this Thursday of $5.39 per share on sales of $4.23 billion. That represents a paltry 10% earnings growth with sales expansion at about 4%. The shares have already run up $100 in the last three months alone, so there is a reasonable chance that most of the run-up has already been factored in.

This could be a classic example of buy the rumor and sell the news. The love affair the analysts seem to have with GOOG makes me wonder how much “pump and dump “ action is occurring. The simple truth is GOOG’s forward multiple at 21 times '09 estimates is almost 75% higher than IBM’s forward PE of 12.
FBR capital was the latest research firm to fall all over GOOG, raising its one-year target price 23% from $535 to $660, yet notched up its 2009 earnings estimates less than 1% from $21.91 to $22.03. Where is the logic here? The stock target is raised by a factor of 23 times the expected earnings gain. I guess many investors look at GOOG’s high in Dec of 2007 of $715 as attainable again. It could happen, but back then GOOG’s earnings were growing at four times the amount they are today, so maybe its high price was more justified back then.
Google's market share of the search market fell for the first time in July. GOOG lost almost a 100 basis points from 78.44% to 77.54% while Microsoft's (NASDAQ:MSFT) Bing saw its market share surge over a 100 basis points to over 9%. Although Yahoo (YHOO) and MSFT barely have a 20% market share between them, many believe their upcoming partnership will enable them to grow that number further pressuring GOOG’s pricing power and dominance.
Bottom-line: No doubt GOOG is on a roll, but at this juncture its risk reward ratio does not warrant further investment. Earnings will be great, but will have to come in above the most optimistic whisper numbers to keep the shares from sliding. If GOOG misses, the shares could lose 10%-15% in a single session, falling as low as the $460 area. This would represent a compelling entry point, constituting about a 50% retracement from its three month staggering run from $400 to $525

Disclosure: short