Sunday, September 23, 2007

Revisiting Google (GOOG) vs Apple (AAPL)

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Let's revisit one of the market's favorite stocks: Google (GOOG) which has shown signs of life lately. All earlier Google posts are found here, and my specific concerns from late August about the stock in terms of advertising slowdown from financial firms are found here. Barron's got on board with this thesis, this weekend, click here to see the story. With that said, Google is incredibly dominant in search, and along with Apple (AAPL), changing the way we do things in the technological world.

The bear case is Google is specifically levered to advertising, and specifically the ad world, especially online, is heavily based on spending by financial firms, many of which were mortgage companies. The bull case is "well this is Google (GOOG)", they have cut back on some of their labor spending which was very heavy in the past few quarters and a drag on earnings, and advertising is migrating from offline to online so as a secular trend any slowdowns from the financial space can be made up from other new advertising initiatives. Also there is the YouTube monetization although the case for that has yet to be made clear.

On a valuation basis, Google is not outrageously priced for a company which should be able to put 30-35% earnings growth as a realistic target in the next 3 years - the forward PE on 2007 is 36, and for 2008 it is 29. Now it is not cheap, and Google generally beats analysts estimates by a good amount, although last quarter they only 'met' expectations. Depending on how much they pulled back on new hiring, they could certainly beat the estimates of $3.75 this next quarter especially considering they did $3.59 in the previous quarter - $3.75 would only indicate a 4.5% sequential growth in EPS - very do-able. But is that enough to warrant this sort of valuation anymore? One can find 4.5% sequential growth in many companies. I still think there are some risks with the ad spending, even though they are destroying Yahoo (YHOO) in search.

The stock has jumped from about $525 to $560 since our friend Helicopter Ben told us it's cool to speculate again, which in dollar terms sounds like a lot but it is only 6.7%. I still think the easier money is to be made in other names, although a run to $600 is certainly in order and the stock chart now looks very good with the action the past 4 days. Even if Google can make a run to $700 from here in the next 3? 5? months that is a 25% gain. Not shabby, but I think there are so many other candidates where 25% gain can be had much easier. And if the general US economy either drops to sub 1% GDP growth and/or outright recession (however shallow) will ad spending (lifeblood for Google) continue at previous pace? Is Google that immune? Hard to tell - more importantly if the market has any questions/concerns some PE multiple contraction might happen. Hence, as much as I love Google as a company and all the great initiatives they are doing to make the web and our world easier and more interactive, this company has reached the sized that diminishing returns start to take effect. It's market cap is $174B, so a move to $700 would move the market cap to $220B. While I do think by simply cutting back hiring they can 'beat' the number, and investors might go giddy, the next 3-6 quarters (assuming a US economy slowdown) are more of a concern to me. Google is still tethered more to the US economy than most other stocks in the portfolio.

For comparison let me throw out another larger cap tech darling stock, Apple (AAPL), which currently trades at $144 and a market cap of $125B. To reach a market cap of $220B (or Google's value if stock price is $700), Apple would need to reach $253 or 76% higher from here. Analysts are pegging a growth rate of about 34% for Google in the next 5 years, versus Apple 24%... I think these 2 rates might converge, with Google going a bit below trend and slowing to upper 20s/lower 30s, and Apple above trend to mid to upper 20s. Hence I continue to favor Apple (AAPL) over Google (GOOG) - all things being equal (i.e. Steve Jobs not spending most of his afternoons in a court room) Both companies are literally changing our world for the better, and ironically while Google has far less competitors than Apple, I think the markets Apple addresses are bigger and more varied (cell phone, computer, music, tv distribution et al). Keep in mind, in it's core business, computer hardware, Apple still only has a 3% market share... just a double there over 3-5 years will mean significant earnings revisions upward.

Long Google and Apple in fund; no personal positions





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