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Google's Lag Lingers

Vishesh Kumar

Five full months into 2007, Google(GOOG) shares are on track to be the worst performer among Internet giants this year.

The stock, which closed Friday at $483.52, has traded sideways since the start of the year and is up only 4% since early January 2006. And the shares continue to command a remarkably poor valuation, especially considering the company has delivered nothing but stellar earnings and is tagged with enthusiastic buy recommendations by a number of high-profile investment banks.

Google trades at only 25 times forward earnings -- lackluster by Internet standards, particularly given the bullish growth forecasts by many on Wall Street. "Internet stocks historically carry PEG multiples [a combined ratio of valuation and growth] closer to 1.5x," American Technology Research analyst Rob Sanderson wrote in a research note last week. "But Google is only half this ratio despite being the clear powerhouse."

So why, as Sanderson points out, is Google essentially stuck "at its all-time low for valuation"? Sell-side analysts on Wall Street are puzzled about why a stock so unequivocally supported by them seems stagnant. One fund manager described the failure of the stock to perform as simply "perplexing."

While there aren't any easy answers, there are a number of tangible things keeping the stock from breaking from its range-bound ways.

For starters, most big money managers who are able to move markets when they gobble up stocks already own Google, says S&P equity analyst Scott Kessler. That leaves very few major players scrambling to get in -- and, as a result, less stimulus to bid up shares in the process, he says.

Indeed, Google's current blue-chip status among many fund managers stands in sharp contrast to how the stock was regarded in its public debut less than three years ago. Then, the company chose to go public in an unorthodox method and slowly gained legitimacy on Wall Street. A mushrooming market cap and mounting earnings made large investors both able and wanting to buy shares -- which helped fuel the stock's initial explosive trajectory.

But Google, a part of the S&P 500 index since March 2006, is anything but an emerging, fringe player these days. "Most large growth managers already have significant exposure to Google," writes Sanderson. "Who is the incremental buyer of the stock?"

Analyst projections for Google may also be unduly rosy, says Kessler, whose $525 price target for the stock has been more conservative -- and more correct -- than most. (The median price target for the stock is $600.)

Expenses for options are usually not factored into Google's stock price, even though they are for many other Internet companies, including Yahoo!(YHOO) and CNet(CNET), Kessler says. The relatively short amount of time that Google has been public -- combined with its almost always upward-moving price over that period -- can also lead to muted assumptions about the stock's volatility, a factor that's used by analysts to determine price targets.

Predicting the five-year growth rates often used in calculations can be especially tricky for a company in a fast-changing business.

Doubts about whether the search ad business -- which makes up almost all of Google's revenue, putting $10 billion in its coffers in 2006 alone -- can keep growing at a blistering pace may also be giving investors pause, Sanderson believes. But that's because they may not fully understand the international opportunity the search giant is looking at.

"The intuitive bias that the law of large numbers is catching up does not appear to be the case in most of Google's end markets," Sanderson wrote. The U.S. and U.K. made up 72% of Google's revenue in 2006. But other developed-country markets where Google is dominant (with more than 70% of market share) have a total GDP 11% larger than the U.S. and U.K. duo -- and 35% more broadband subscribers.

"Clearly, growth in international markets can keep extraordinary growth going for Google," wrote Sanderson, who has a $600 price target on the company. "We believe it is only time that stands in the way of capturing this opportunity."

Sanderson is probably right that Google's search opportunity is being overlooked. But time can also be a pretty annoying obstacle, as Google shareholders must be realizing by the day.