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Ask any investor in the Internet sector what's on his mind for 2006 and chances are he'll say Google (GOOG:Nasdaq) . Will the stock continue to soar or will it finally come back to earth?
Well, we have some encouraging news for this Internet investor, and a few other stocks in the Internet sector that he should consider as well.
But first, the Google dilemma. Google is, hands down, Larry Haverty's favorite search engine. The veteran money manager uses it to look up movie listings and all sorts of other data.
But when it comes to investing, Haverty much prefers the stock of rival Yahoo! (YHOO:Nasdaq) , which he says is cheaper than its Silicon Valley rival. For one eye-popping figure, consider the price tag the market is attaching to each worker at the Internet giants, Haverty says. Going by recent data, each of Google's 5,000 employees is worth more than $25 million, based on the company's $126 billion market cap.
"That's expensive," says Haverty, whose Gabelli Global Media Trust fund owns a stake in both stocks. By the same measure, using recent figures, Yahoo!'s 9,600 workers are valued at a mere $6 million or so apiece.
Haverty's unease about Google's shares is hardly uncommon. Skeptical investors have been questioning the value of the Mountain View, Calif., company ever since it exploded onto the scene in a closely watched August 2004 initial public offering. At the time, the stock fetched $85, a level that was already raising eyebrows among the so-called value investors who seek out stocks using various quantitative measures.
Now, Google trade above $400, having more than doubled this year and quadrupled off its IPO price. Gowth managers, including Thrivent Financial's Mike Binger, say the ride is far from over.
"It was too expensive at $200 and too expensive at $300," says Binger. "Until the numbers show that they won't have these spectacular growth rates anymore, we are going to continue to own it."
Google's unstinting rise has divided investors into two camps, those who agree with Haverty and those who side with Binger. Figuring out which group has the bulk of the evidence on its side is a monumental task, given the fast-changing nature of the Internet and the media business. And just for good measure there's a third group of investors who are betting that even if Google doesn't continue to soar, the trends that sent it skyward will lift smaller players.
Google's stock is tough to handicap in part because the company doesn't provide earnings guidance and is at the forefront of an industry that many observers say is in its infancy. But Binger argues that people can find the real strength in Google merely by looking at its sequential growth. In the third quarter, revenue rose 14% from the second quarter, while net income increased 11%. Those are strong numbers indeed, considering how rare it is to find companies growing at such a rate year over year.
Noting Google's continued strength, five analysts have raised their price targets on the stock since it hit $400 on Nov. 17. The most bullish price targets now reach $500.
"One factor that we believe gets overlooked by the market in focusing on (the company's) absolute stock price is that in a relative basis it's actually valued similarly to other net leaders," wrote Citigroup analyst Mark Mahaney, in a Dec. 8 note to clients. He raised his price target to $490 from $430 and rates the shares as a buy.
Based on Wall Street's 2006 earnings estimates, Google's price-to-earnings ratio is 46 and its ratio of enterprise value to earnings before interest, taxes, depreciation and amortization is 29. That is in line with Amazon (AMZN:Nasdaq) , eBay (EBAY:Nasdaq) and Yahoo!, Mahaney says.
Google, which gets most of its revenue from advertising, should also continue to benefit from the still-growing popularity of search among advertisers. Forrester Research estimates that U.S. search-engine marketing spending will hit $11.7 billion by 2010, a gain of 170% from 2004.
Even with all of those factors going Google's way, some analysts and investors say that there is still good reason to be cautious.
Google's position on top of the search engine market is under assault from well-funded rivals including Microsoft (MSFT:Nasdaq) . In addition, Google continues to develop nonsearch services and products, with mixed results. For example, some advertisers have criticized the company for rushing Google Base, the free listings service, into testing before it was ready.
"It's not terribly difficult to build a search engine," said Rick Summer, an analyst with Morningstar, which puts the fair value of Google's shares at $254. "The technology is not why Google is successful in search. Brand is very important, and it would take a real effort for anyone to take customers away from Google."
Finding bargains in the Internet sector isn't easy, since many stocks including Yahoo!, the most popular Web site, have shown big gains and are near their price targets. Still, many of the same trends that are helping Google are helping companies that do business with the Internet behemoth and compete against it.
Like Google, ValueClick (VLCK:Nasdaq) is benefiting from the shift of advertising online. The Internet advertising services company also is a favorite of Wall Street. Eleven out of the 14 analysts who follow the online advertising firm recommend purchasing its stock. The average target price for the shares, which currently trade around $19, is $21.60, according to data compiled by Bloomberg.
"The fundamentals are solid," says Hoefer & Arnett analyst Martin Pyykkonen, who has a strong buy rating on the stock and doesn't own it, in an interview. "There is upside to '06 numbers."
Pyykkonen expects ValueClick to make 60 cents a share next year based on generally accepted accounting principles and 72 cents on a so-called pro forma basis, excluding certain costs. He has a price target of $23.
Yahoo!, which is second to Google in the search market, also shouldn't be ignored, according to Pyykkonen. Indeed, 24 out of 35 analysts rate the most popular Internet site as a buy, with an average price target of $43.22, Bloomberg says. It currently trades around $40.84.
"Yahoo's relationship with big advertisers is broader and deeper than Google," Pyykkonen says. "It's not to say Google can't catch up. Right now, Google has the upper hand in paid search and Yahoo! has the upper hand in branded image ads."
IAC/InterActive (IACI:Nasdaq) is another Internet stock gaining favor with Wall Street. Ten out of the 18 analysts who follow the New York-based company, which owns the Ask Jeeves search engine, rate it as a buy. Their average target price for the New York-based company, which recently traded at $27.69, is $32.50. Piper Jaffray analyst Safa Rashtchy's target is a bit more ambitious at $32.
"The stock is not owned by the same growth investors who have Google and Yahoo!," says Rashtchy, who rates the shares outperform and doesn't own them.
Another interesting play is HouseValues (SOLD:Nasdaq) , says Rashtchy, though he adds it's been a target of short-sellers. He praises the company, which provides services for realtors, for its "not so sexy business model." His target price for the stock, which traded recently around $14, is $23.
Analysts have also taken a shine to E.W.Scripps (SSP:NYSE) , the media company. Scripps owns the Shopzilla.com comparison searching engine along with cable channels with popular Web sites such as the Food Network. Their average target price for the Cincinnati-based company, which trades around $48, is $57.60. Ten out of 17 analysts say the stock is a buy.
"This is overlooked," says Edward Atorino, an analyst with Benchmark who recommends the shares but doesn't own them. "Shopzilla is exceeding all expectations."
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