The Bear Club: GOOGLE

Thinking Big
20 Dec 2005

Google joins the small caps among leaders in accelerated earnings growth.




Paul DeMartino

Reuters.com

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Please readthisfirst: Following isan independent investment commentary and analysis from theReuters.com investment channel expressing views that are notconnected with Reuters News.


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Probably quite a few Google (GOOG) watchers are trying to figure out the attraction of spending $1 billion for 5% of Time Warner's (TWX) AOL, but the prospective deal hasn't dimmed any of the demand for Google's stock. Google also recently appeared on the Reuters Select Accelerating Earnings-Per-Share screen.

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This week we're highlighting the Accelerating EPS screen, our in-house champion for 2005. The screen filters for companies where earnings, the share price and analyst outlooks are improving.

Analysts have lifted their estimates for Google's profits over the last two months. Think about that for a moment. Three-fourths of Google's current fiscal year is locked in and yet seven analysts still revised their estimates upwards in the last month, even with a December year end. Many of the companies that are currently on the Accelerating EPS screen are not on a December year end. There are, for instance, several retailers on January-ending cycles. That, at a minimum, augurs well for fourth-quarter results at the search engine. That said, one analyst has also cut the December quarter rating in the past month.

The first few criteria that lead to a berth on the screen are all related, of course, to earnings growth - a hurdle Google quickly surpasses. Google's three-year average annualized growth rate is 285%.

Growth Rates(%) Company Industry Sector S&P500
Sales(MRQ) vs Qtr. 1 Yr. Ago 95.87 45.19 17.60 16.57
Sales(TTM) vs TTM 1 Yr. Ago 96.67 40.09 17.63 16.77
Sales- 5 Yr. Growth Rate 579.60 16.88 10.20 9.71

EPS(MRQ) vs Qtr. 1 Yr. Ago 596.30 8.73 11.60 17.76
EPS(TTM) vs TTM 1 Yr. Ago 442.31 74.80 25.12 19.94
EPS- 5 Yr. Growth Rate NM 32.37 10.85 13.68

CapitalSpending - 5 Yr. Growth Rate NM 4.63 -1.05 3.89

Learn about Growth Rate Ratios



The screen further requires that trailing twelve-month (TTM) EPS growth be greater than three-year EPS growth. Finally,the latest quarter must be greater than the TTM growth rate. Clearly, this is true as well, by a large margin.

The final two screen criteria are separate from growth rates. Analyst estimates for the current-year EPS must be greater than it was eight weeks ago. The consensus is currently $5.90; two months ago it was $5.63.

The final hurdle for inclusion on the screen: the stock price had to have outperformed the industry average over the past four weeks. GOOG was up 7.5% in the last month while the average computer sciences company wasup only 3.8%.

Google is unique among even the other Accelerating EPS screen members in that it is the largest company on the screen by a wide margin. In terms of market capitalization, the next-largest company on the screen is the miner Rio Tinto Limited ADR (RTOLY), which is just over half the size of Google. Burlington Resources (BR)is number three, and it's about a quarter the size of Google. The next ten companies, combined, are slightly larger than RTOLY.

In short, growth the likes of which Google is displaying is usually the province of small- and micro-cap stocks with favorable timing. As a company grows larger, it is supposed to settle down, looking at safer, steadier growth. Looking into my crystal ball, Google is still going to be roped in by the laws of economics eventually. Still, in many ways, Google seems to be a company still in its nascent growth phase.

Strategically, the $1 billion that Google spent has several potential purposes. First, the pending deal cements a former agreement with AOL that is still quite lucrative for Google; Derek Caney's article notes that analysts believe that it accounts for between two and four percent of revenues.

The AOL offer is also another swipe in Google's knife fight with Microsoft. Considering that Microsoft had approached AOL about replacing Google in AOL searches, spending $1 billion to deny that opportunity to it could be considered money well spent in competitive Silicon Valley.

The point here is not that the AOL deal will boost Google's bottom line directly; the point is that Google, even as it appears to act defensively, is still widely expected to keep finding opportunities start-ups would be envious of.