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The Bull and Bear Trade in Google (GOOG)

|Includes: AAPL, Alphabet, Inc. Cl C (GOOG)

With a FY-2010 earnings estimate of $27 per share (the low end of analysts' expectations), Google is sporting a 32% earnings growth estimate and is trading at a Forward P/E of 18.  To put Google's Forward P/E of 18 into perspective, we need to look at its historical average.  GOOG's 5-year historical P/E average is 46.9.  With annual earnings of $27 per share (the low end for the year), a P/E of 46.9 would put Google's stock price at $1266.30.  However, with a slowing and somewhat uncertain economic world recovery combined with GOOG's recent move to pull out of China, Google does not deserves such a multiple.  Although, I would argue that a forward P/E of 18 for a company as historically dominant as Google seems silly.  A more suitable P/E for Google would be slightly above the industry's average P/E of 25.7, let's say a P/E of 26.5.  If GOOG were to maintain annual earnings of $27 in 2011 and growth in the internet and technology sector continues to expand and be in high demand GOOG seems very undervalued.  My price target for Google is $715 (forward annual earnings of $27 per share times my hypothetical P/E of 26.5 (slightly above the industry's average of 25.7).  Analysts are expecting annual earnings of $30 per share for Google in 2011.  At GOOG's current price of $482, the company is trading at 16x 2011 earnings.  A P/E of 16 would be comparable with the historical P/E average of the S&P 500, however, GOOG presents much better future growth potential, cash flow, and a well established and defined economic moat than the index.  Google's other valuation ratios look cheap as well.  Price-to-sales of 6.3 is half of Google's 5-year historical average of 12.  Price-to-cash flow of 16.2 is much less than the firm's 5-year historical average of 24.8.

If worldwide demand for technology continues to expand for years to come as it has recently, Google is extremely underpriced.  The firm has proven itself as the dominant market player.  Apple (NASDAQ:AAPL) has taken shares in the cell phone and apps market, but Google could see a strong comeback if the AdMob deal goes through and if the Droid X sees high demand.

Some potential unexpected bullish catalysts:
1.  Google could very well get back into China, or work out some type of deal with the Chinese government.
2.  The FDC files for a request for preliminary injunction against the Google AdMob deal, but GOOG challenges and wins.  This would place Google at a great competitive advantage in the mobile display advertising market.
3.  Advertising spending continues to pick up and the uncertainty in the world economies settles.
4.  The Driod X takes the cell phone market by surprise and Google takes market shares from Apple.

Since peaking in late December 2009/early January 2010 Google (NASDAQ:GOOG) has been consolidating nicely and is beginning to look attractive once again.  The recent pullback has brought GOOG all the way back down to its intermediate-term support line on its three year weekly chart.  If GOOG can hold support, which is currently around $480, and can advance to a weekly close above $530, this would mark the completion on an ABC correction and the stock is likely to advance to a new high.  However, if GOOG breaks down below its uptrending support (the $480 level), this would mark the completion of wave #4 on what potentially could be a 5-wave correction pattern.  In this case of scenario, the next support level would be somewhere between $420 and $400, where Wave #5 would most likely be completed.  No action is to be taken on GOOG as of yet, but a profitable trading opportunity is sure to occur very soon.  GOOG would be a buy on a weekly close above $530 (a bullish breakout), or GOOG could be a quick short on a weekly close below $480 (a bearish breakdown and the completion of Wave #4).  If GOOG does breakdown below $480, it would be recommended that shorts cover somewhere between the $420 and $400 range as GOOG should find solid support here and complete its 5th Wave of a potential 5-Wave correction.

Below are the technical charts:

Disclosure: None Mentioned

Disclosure: None Mentioned