Google: Rational Exuberance?

Unless Google outstrips analysts' third-quarter estimates, its stock may retreat from record highsbut probably not for long

This is no time for Google's shares to be reaching all-time highs. It's not that the company's performance doesn't warrant a lofty stock price. Fresh statistics from researchers at comScore (SCOR), for instance, showed Google (GOOG) accounted for 37.1 billion, or 61%, of the 61 billion Web searches carried out globally in August.

No, the problem with Google's stock reaching a record $625.39 on Oct. 10 is that it comes a matter of days before the company releases third-quarter results. Even gravity-defying Google can't always surpass analysts' forecasts as much as some investors hope.

Google Stock: Brief Drop?

And this time around, expectations could hardly be higher for the online advertising giant. Fueling this week's multiple records are projections from well-known analysts such as Henry Blodget, who speculated Google could someday top $2,000 a share. "Name one company that is better positioned than Google to one day have a $1 trillion market capitalization," wrote Blodget in an Oct. 2 post on Silicon Alley Insider, a tech business blog.

He's got a point. Despite regularly cautioning investors that growth will someday slow from its meteoric pace, Google has made a habit over the years of outperforming analyst estimates. Take results from last year's third quarter (BusinessWeek, 10/20/06), when Google generated $50 million more than Wall Street's lofty estimate of $1.81 billion in revenue, leading to a nearly 8% gain in the stock. With the stock steadily rising this time around, investors clearly anticipate another beat-and-raise quarter.

Yet unless Google tops The Street's consensus forecast of $3.75-a-share earnings growth—say, by posting $4-a-share growth or more—the stock may be headed for a drop next week, if only briefly, analysts say. "People are bidding it up on the expectation of a strong quarter," says Tim Boyd, an analyst with American Technology Research. "It is bidding up on momentum." Analysts also expect a 57% increase in sales, to $2.9 billion. UBS (UBS) analyst Benjamin Schachter adds in an Oct. 9 research note, that "high expectations leave little room for significant upside."

And plenty of room for the opposite. Google's stock declined nearly 7% in the two trading days following its July 19 announcement (BusinessWeek, 7/20/07) that revenue had grown 58% from the past year, to $3.87 billion. The reason? Per-share earnings fell shy of some analysts' exuberant expectations and failed to exceed the high EPS growth recorded in past quarters. Google blamed the shortfall on having hired more aggressively than executives originally planned.

Advertising Spending Resilience

Google sometimes gets no slack even when it beats expectations. Google shares slipped in extended trading Jan. 31 after it blew away revenue forecasts (BusinessWeek, 1/31/07) for its fourth quarter, posting a 67% increase.

What might have slowed Google's growth engine last quarter? The downturn in the housing market and credit crunch caused some lenders and banks to cut back on ad budgets, and financial services was the second-largest category for Internet advertising in 2006. However, because Internet advertising is cheap and the return on investment is easily measured, it's not expected to take a big hit this time around.

Indeed, should Google fail to impress next week, its shares are unlikely to stay down for long. Despite its high share price, the stock is trading at a multiple comparable to other stocks in its sector. On Oct. 9, Banc of America Securities (BAC) analyst Brian Pitz raised his target for Google's shares to $670, saying he expects results to be propelled by accelerating growth in U.S. search queries, gains in overseas markets including China, and scant signs of slowdown in ad spending by financial firms. Further out, Pitz says growth catalysts include Google's forays into mobile Web services and an increased ability to generate sales from its YouTube online video business.

So even if Google shares pull back in the coming days, they may be setting new highs before long.

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