Google Looks Too Cheap to Ignore

by: Ockham Research October 01, 2008 | about stocks: GOOG    

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Tuesday afternoon was an odd one for Google, Inc. (GOOG) stock and an embarrassing moment for the NASDAQ Exchange. We noted right away—as I am sure many in the investing community did—that GOOG was tanking right before the close. Around the office people began to wonder about hedge funds or other institutional investors liquidating their positions at the quarter end. We speculated that value investors would be drooling over Google at the quoted prices; depending on the source you trust, GOOG actually got down to $25.80 (CNN Money) or even one penny (Reuters)!GOOG

As it turns out, it was all much ado about nothing. It was a major glitch, as a spokeswoman for NASDAQ explained, “A market participant sent in a large number of orders and drove the price down at approximately [3:57p.m. ET] which caused the bid-offer to be artificially low due to their mistake.” It’s funny that an exchange which is exclusively electronic would blame a participant for the mistake instead of the entity that allowed the trade to occur. Anyway, the erroneous trades are being wiped out and NASDAQ set the closing price of GOOG for September 30, 2008 at $400.52, slightly above where it began the day. Aren’t computers supposed to make market trading more efficient?

Back to reality, GOOG shares in the low $400 are too cheap to ignore according to our methodology. We at Ockham Research are huge fans of Google’s products which are indispensable to our daily workflow. Google is one of those iconic brands whose name has become a part of speech. One does not search the web anymore; it’s simply referred to as “googling”. Other brand names that come to mind which have entered the lexicon of business are Xerox (XRX) and Tivo (TIVO).

Google is now so much more than a search engine. The company is constantly expanding into new territory, such as: its new web browser Chrome, the Android platform for its G1 phone and even a partnership to explore alternative energy with General Electric (GE). We do not know whether these products will eventually become dominant market players, but they are interesting prospects. We wish Google all the best—especially in finding cheap and clean energy sources—but as an investor, we prefer to ponder observable successes, such as that which GOOG has enjoyed with its search engine.

Internet users are searching the web more than ever. A Pew internet usage report from 2002 showed that only 33% of internet users utilized a search engine daily; in 2008, that number is almost 49%. That is half of every internet user every single day! Google is gaining market share in search engine usage as well. On many months, Google gets a dominant 70% of all searches versus competitors Yahoo (YHOO) and Microsoft (MSFT). This equates to more revenue via its core business of internet advertising.

In terms of valuation, $400 per share may sound pricey but it clearly is not, based on historical valuation ranges. GOOG has fallen rather rapidly during 2008 from its high of nearly $750 in November 2007. That’s a drop of 46%, yet its revenues continue to grow. Furthermore, on a Price-to-Sales basis, GOOG has normally traded between 8.65x - 16.1x in its short history. However, the current Price-to-Sales metric looks cheap in comparison at 6.9x. Similarly, Price-to-Cash Flow, which is currently 22.2x, has historically ranged from 29.4x - 55.8x. Being a value shop, we rarely find such great growth stories this undervalued. We have awarded GOOG an Undervalued rating as it has been over-sold in this market and we think it is reasonable to expect GOOG to rebound into the mid $500s going forward.

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This article has 11 comments:

  •  
    Oct 01 04:16 PM
    No way... Google is on the way back down, like AOL and Yahoo! after it. They are just another unfocused internet startup with little experience, too much cash and a lot of hype.

    Most of their revenue is advertising which is gonna fall, and much of that is mortgage advertising they already got paid for and need to work through the system.
    Reply | Link to Comment
  •  
    Oct 01 04:21 PM
    Google is not a bargain at all. They are unfocused, and have too much cash and hype. AOL and Yahoo! before them followed the same path.

    Most of their revenue is advertising, which will drop in a recession, and much of that is mortgage advertising which they already got paid for and need to work through the system.
    Reply | Link to Comment
  •  
    Oct 01 04:35 PM
    Let's see. Google is basically an advertising company with a P/E of 27 in a debt based economy that is collapsing.
    Reply | Link to Comment
  •  
    Oct 01 04:54 PM
    "Let's see. Google is basically an advertising company with a P/E of 27 in a debt based economy that is collapsing. "

    whoa, whoa, whoa..... last I checked they were only 98.9% ad-based revenue... but seriously, you are spot on.
    Reply | Link to Comment
  •  
    Oct 01 04:58 PM
    I think most people who use Google see a lot of junk in the search results--I certainly do. But they keep using Google because the current competitors are no better--and probably worse.

    So I think Google is vulnerable to someone who builds a better mousetrap. I think there is a reasonable chance this will happen. And if it does Google's big lead could evaporate quickly.
    Reply | Link to Comment
  •  
    Oct 01 05:44 PM


    "I think most people who use Google see a lot of junk in the search results--I certainly do. But they keep using Google because the current competitors are no better--and probably worse.

    So I think Google is vulnerable to someone who builds a better mousetrap. I think there is a reasonable chance this will happen. And if it does Google's big lead could evaporate quickly."

    They are not vulnerable, they own information. No start up could match the speed and quality of their servers and will have a hard time monetizing it. They win because they make good user experience and gained trust. While I agree that switching search engine is no big deal technically speaking, it is in terms of quality.
    Reply | Link to Comment
  •  
    Oct 01 10:15 PM
    The best part of the above was "being a value shop..."
    Reply | Link to Comment
  •  
    Oct 02 03:02 AM
    The best part of the above was the guy that's facinated with the line 'being a value shop..."
    Reply | Link to Comment
  •  
    Oct 02 11:57 AM
    when the market is collapsing, don't quote me price to sales ratio. All I care about is PEs <15, Div Yield (it has one), and EPS growth being positive.
    Reply | Link to Comment
  •  
    Oct 02 01:20 PM
    I agree with most of the above comments. Google is going down. If you want to invest in online, why not look at SOHU, which exhibits some amazing numbers. China may not be participating in the world commodity resurrection, but it would seem that its online growth may have 'decoupled' from the rest of the world. The reason for this is that there is a language and cultural 'Great Wall' that Google can't seem to surmount. If you want tried and true, look at BIDU... I just think SOHU's numbers are more persuasive.

    Having said that, make sure it has support around the $50 -> $51 range... Looks like a double bottom there... And do use a tight stop.. I don't think I'd let it drop any further than $49.... You might want to wait to see if the House of Representatives is going to torpedo the bailout first as well... If they do, Heaven help us all..

    jegan ;-)
    Reply | Link to Comment
  •  
    Oct 07 09:58 AM
    Google's a tough call. Despite the risk, I'd pick up a long position at $290-300, with a few puts just in case.
    Reply | Link to Comment
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