Googlicious

In spite of making my share of blunders in the stock market I continue to win more than I lose. One of my biggest current winners is Google. I was late to the party, getting in last October at $410, almost 5X the IPO price of $85. I was also brave (or reckless?) enough to buy $450 Jan '08 calls when Google dropped to around $430 earlier this year. Now I look like a genius.

Google's growth is truly astounding considering how large the company already is. It continues to defy the law of large numbers. It is criticized for being a "one trick pony", but that is some trick. This week Google announced results for its 3rd quarter: revenue increased 57%, profit increased 46% year over year. Google has more than $12B in cash and continues to make very large capital expenditures in both infrastructure (e.g., data centers) and R&D.

They have quite a few initiatives in order to diversify the business. But these initiatives are largely focused on their stated mission of advertising across different medias and devices, organizing the world's information, and monetizing the access of that information.

Google continues to take market share in every country where it competes. The highest market share is in the U.K., an astounding 70% and going up! About half of Google's revenue comes from outside of the U.S. making it a play on the strengthening currencies in Europe and the emerging markets. Compared to say, Ebay, Google's international strategy and execution has been excellent.

Is Google an expensive stock at a price of $644 per share and a P/E of 32 times forward earnings? I read an article by an analyst claiming that based on this and a number of factors, such as selling at more than 9 times book value, that Google had to be overvalued. This analyst falls into the trap of trying to apply financial ratios and stock evaluation metrics uniformly across all industries. Many technology companies, particularly software companies, sell for a large multiple of their book value.

Even Microsoft, a stock that has gone absolutely nowhere for years, while increasing revenue and earning dramatically, has a price/book ratio of over 9 (based on today's closing price Google's price/book ratio is 10.1). Now if you ever found a bank selling for 9 times book value it would be the short selling opportunity of a lifetime.

Let's compare Google to some of the other technology high-fliers and its direct competitor Yahoo (not a high flier).

Google has a forward P/E of 32.58, a PEG of 1.23 and a profit margin of 27.48%. The P/E and PEG ratios assume that analyst's estimates for 2008 are correct (Google does not provide guidance). Google has beaten estimates almost every quarter, often by a wide margin. That means that it that PEG ratio could actually be too high. Conventional wisdom on Wall Street is that a company with a PEG of less than 1 is a value play.

Amazon trades at a forward P/E of 57.91 and a PEG of 3.55. Just for fun the price/book for Amazon is 67.45. Amazon has a profit margin of 2.51%. Why does the profit market look like is belongs to a grocery store? Because Amazon is retail company, with the margins of a retailer. But it trades like a technology stock. I continue to hear that Amazon is going to blow out earnings this quarter; perhaps they will. Amazon bulls point to the potential for growth in China and leveraging its infrastructure by being the technology and fulfillment provider for other on-line retailers. Nevertheless I can't get comfortable with Amazon, but you can't short it. Traders shorting Amazon have been the road kill of Wall Street this year.

Research in Motion has a forward P/E of 36.38, a PEG of 1.6 and a profit margin of 20.7%. RIMM has a defensible franchise, giving it a narrow moat. RIMM is growing like mad and dominates the business side of mobile push e-mail.

Apple has a forward P/E of 37.21, a PEG of 2.04 and a profit margin of 13.85%. Lower component costs for the iPods are benefiting gross margin. Apple is taking market share in PCs. The iPhone has been a phenomenal success and will soon launch in Europe and the U.K. Apple continues to be the world leader in turning complex technology into easy to use technology.

Yahoo has a forward P/E of 53.76, a PEG of 2.84 and a profit margin of 10.98%. Yahoo can't get out of its own way. It has not been a good short but I wouldn't buy Yahoo with your money.

The risk with Google is that its earnings growth suddenly slows resulting in multiple contraction. It certainly appears that Google's growth will continue to be impressive for some time. Assuming the DoubleClick deal closes, which Google was positive about on this week's conference call, Google will grow its dominance of on-line advertising.

DoubleClick will make Google a leading provider of display advertising verses the text advertising that is currently its largest driver of growth and income. They have the money and enough time to diversify its lines of business. I'm not going to bet against them.

Disclosure: at the time of this posting the author was long GOOG, RIMM and AAPL.