(GOOG) Google Growth Cheap at 16 Times Earnings

Google Inc. (GOOG) reports earnings after the close on Thursday with consensus EPS expectations for the fourth quarter inching up to $10.50 this week. The Zacks consensus estimate, which accounts for Employee Stock Option expense, is $9.06. Since the company doesn’t give guidance, the high/low of the estimates is nearly $2. In other words, GOOG earnings are always a fireworks event.

When I covered the October Q3 report two days beforehand, I highlighted that the stock was poised for a big move because the stock was undervalued at $550 and options volatility was high (indicating high risk). I thought the odds were better than not that GOOG would surprise with an earnings beat and I was right as their strong results drove the stock up to $600.

Today, I am also bullish on GOOG but I don’t think we’ll get another $50 surge. The stock is much more fairly priced now around $635. Is it worth $750? Yes it is because it is growing parts of its business at 40% and the entire company at 20% in many exciting directions so paying a 20X forward multiple for that growth is reasonable.

Will institutional investors pay a 20 multiple right now though? I don’t think so. I think they are buyers at 15-16x forward estimates of $38 ($575-$610) and will sell on rallies toward $700 as we saw earlier this month on concerns about MMI integration and costs.

Why GOOG Looks Bullish Above $600

I think there are so many interesting things to talk about with this company and its stock that I almost don’t know where to begin. But I will highlight the fundamental and technical reasons for my bullishness.

I will show you the chart first. That line is drawn at $625. It appears that Google’s time has come to reclaim the higher ground above $600 and trading above $625 this week is very bullish. A strong report should keep it there.

There are so many fundamental reasons to like the company and its powerful earnings growth in exciting new businesses, that I am going to just list a few right now. Then I’ll highlight some of the risks, another more detailed article, and how I’m playing ahead of earnings.

  1. Paid search and clicks are still dominant and still growing. Google innovations and their ability to monetize here are relentless. Think of searching for a dentist and getting a useful map of your area with local providers. Those featured ads command as much as $500 a month. Not a bad business to be in.
  2. Google+ is gaining popular at a fast clip and will eventually compete with Facebook, albeit with some demographic differences
  3. Android is positioned for strong growth and will only benefit from the built-in Google intelligence of data/search/ads targeted to demographics and individuals
  4. Video display ads are commanding 8 figures from advertisers who see the value in targeting eyeballs and testing commercials

Finally, there is no argument that Google is embedded in the web and people’s lives. But oddly, they do it in a way that most people don’t resent in a Big Brother sort of way. And they crunch data and innovate business and personal tools like nobody’s business. They have made themselves nearly indispensable with lots of room to grow.

Risks and Potential Rewards

Besides the MMI integration costs, investors will also closely be watching headcount as the company continues to build its army, likely over 33,000 now.

Bottom line: business growth is still enviable, but costs are expanding (eating into margins) and that will make big investors cautious about paying $650 to make 10% when they can diversify into a half-dozen other growth stories and potentially make 20%.

Neutral-to-Bullish Options trade: This is a conservative bullish play that only needs the stock to stay above $600 to earn a 25% return on risk. Buy the March 550/600 call spread for $40. Potential return of 25% in two months.

A lower risk options trade: Buy the February 560/580 call spread for $17.50 for a potential return on risk of 14%.

GOOGLE INC-CL A (GOOG): Free Stock Analysis Report

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