Tuesday, August 23, 2011

Google's a Buy At Current Levels

S&P downgraded Google (NASDAQ: GOOG) to sell last week after its $12.5 billion acquisition of Motorola Mobility (NYSE: MMI). Then S&P changed its rating to hold after Google's stock price fell. Should you buy the stock?

On August 16, S&P's Scott Kessler, who I have met with several times over the years, downgraded Google to Sell from Buy. Tuesday, he upgraded Google from Sell to Hold. His reasoning for downgrading it on the 16th was that if Google were to enter the smartphone manufacturing market, the business would be hit with higher costs which would hurt Google's profits and put it in conflict with its current partners who make Android OS handsets.

But now Kessler thinks that the Motorola Mobility acquisition could -- if it is completed -- give Google a strong patent portfolio and that the decline in its stock to $500 a share, S&P's price target -- means that the stock is now appropriately valued after declining 20%.

Is this a signal that you should consider adding Google stock to your portfolio? Here are four reasons to consider the purchase:
  • Low priced. Google's price to earnings to growth ratio of 0.94(where a PEG of 1.0 is fairly priced) means it is inexpensive. Google has a P/E of 18.7 and is expected to grow 19.8% to $37.14 in 2012.
  • Good earnings reports. In a July 15 earnings report, Google announced earnings of $8.76 per share on revenue of $9 billion – 12% and 39% higher, respectively, than analysts’ expectations of $7.86 per share on $6.5 billion in revenue. Including this report, Google has beaten earnings expectations three out of the last five quarters. This ability to beat expectations fairly consistently, and by decent margins, is a good sign for Google's stock price.
  • Out-earning its cost of capital. Google is earning well in excess of its cost of capital and that’s growing. How so? It produced positive EVA Momentum, which measures the change in “economic value added” (essentially, profit after deducting capital costs) divided by sales. In the first six months of 2011, Google’s EVA momentum was 1%, based on annualized first six months' 2010 revenue of $27.2 billion, and EVA that grew from $2.9 billion for the first six months' annualized 2010 to $3.0 billion for the first six months' annualized 2011 using a 9% weighted-average cost of capital.
  • New Revenue Stream in Google+ and Continued Android Success. Google+ (still in an invite only beta-like stage) already has 10 million members and over 550,000 Android phones are being activated per day. With its new Chrome OS operating system just getting started on retail computers, Google is showing that it is much more than just a search engine.
The recent market slump has created some buying opportunities for great companies. With Google trading 27% below its December 2007 all-time high, concerns about the Motorola acquisition are overblown. The company has many strong fundamentals and the stock price does not fully reflect them.


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