Google Gains Give Some Fans Pause

As Google (GOOG Quote) gets hotter, analysts' feet get colder.

On Monday, American Technology Research analyst Mark Mahaney downgraded Google to sell from hold, citing a variety of concerns about valuation and competition.

But rather than give up on the large-cap Internet advertising business going into third-quarter earnings season, Mahaney is proposing a short-term strategy of going long Yahoo!'s (YHOO Quote) shares while shorting Google's.

Mahaney's move follows last week's downgrade of both Yahoo! and Google by Jefferies analyst Youssef Squali, who also based his downgrades on rich valuations rather than fundamental business concerns.

On Monday, Google's shares fell $2.40 to $135.33, while Yahoo!'s dropped 27 cents to $33.90. Since going public in August at $85, Google's stock has soared to as high as $139.88 -- a 64.5% gain in less than two months.

Yahoo! -- an Internet leader in both search-engine advertising and traditional, branded online advertising -- is slated to report third-quarter earnings after the market closes Tuesday, while search-engine operator Google is expected to report its first quarterly results as a public company on Oct. 21.

In his report, Mahaney argues that for high-multiple Internet stocks to trade higher on earnings news, they need to cleanly beat expectations and raise forecasts beyond consensus expectations. Yahoo! -- which has the business model most resembling Google's among large-cap Internet stocks -- is unlikely to have a "beat and raise" quarter, says Mahaney, so Google likely will trade downward on Yahoo!'s news. Additionally, because Google's management has indicated it won't provide guidance, the opportunity for upside potential at earnings time is limited.

Another concern about Google's stock, says Mahaney, is that it no longer trades at a discount to Yahoo!, as he has previously argued it should, based on Google's less-diverse revenue sources, its youth as a public company, its dual-class shares structure and other factors. Based upon the ratio of each company's enterprise value to Mahaney's estimate of 2005 earnings before interest, taxes, depreciation and amortization, the market was valuing the companies equally when he published his report.