Forget Apple -- It's Google's Turn Now

BOSTON (TheStreet) -- In a tech world fixated on everything that Apple (AAPL) does, it's easy to forget that Google (GOOG) is still in business -- and reporting quarterly earnings today.

Apple hogged the media spotlight this week, first on word that CEO Steve Jobs would take another health-related leave of absence and then on a blowout earnings report.

Google, on the other hand, hasn't been in the headlines, aside from its struggle with China over censorship and for its mishandled introduction of the Google TV set-top box.

The key question for investors ahead of Google's fourth-quarter earnings results, due for release at the close of trading Thursday, centers on a big salary increase for workers. In November, Google took steps to retain employees by awarding $1,000 tax-free cash bonuses for the holidays as well as 10% salary increases across the board, effective Jan. 1.

Google rewarded its employees richly in the fourth quarter, but what about the Internet search giant's shareholders?

For investors concerned about the spending habits of Google, the reports of salary increases appeared to be more bad news. Google devoted $1.47 billion toward capital expenditures in the first nine months of 2010 -- $757 million in the third quarter alone. The fear is that Google's commitment to its employees and the costs of funding its projects will lead to less revenue trickling down to the company's bottom line.

Philip Tasho, co-founder and chief investment officer of TAMRO Capital Partners, and Jerome Dodson, manager of the Parnassus Workplace Fund ( PARWX), are less worried than most investors about Google's spending habits.

Tasho, who runs an Alexandria, Va.-based firm with $1.4 billion in assets, says Google demonstrated that, while the company did spend more money to retain key employees in the third quarter, the company delivered big profits.

"They realize it's a balancing act and that they need to invest in their own people to be as good as they are, but they also have to deliver for shareholders, too," Tasho says. "The lag in the stock price probably gave Google more of an impetus to put in more financial controls. They need to invest in the future, which is their employees, so I don't view it necessarily as a negative."

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Google outperformed in the third quarter, posting adjusted earnings of $7.64 a share on revenue of $5.48 billion, excluding traffic-acquisition costs the company pays affiliates for directing users to its network. Analysts were predicting earnings of $6.67 a share on revenue of $5.25 billion.

For the fourth quarter, Wall Street is looking for Google to report profit of $8.09 a share and revenue of $6.06 billion, excluding traffic-acquisition costs, according to a poll by Thomson Reuters.

Google's reputation of a free-spending company has been the biggest headwind for shares. Google's stock fell 4% last year, compared to a 16% rise on the tech-heavy Nasdaq. Tasho says those concerns of Google's spendthrift ways have been holding the company back.

"The criticism is that Google is not keeping their eye on the ball," he says. "The problem with technology companies where cash-flow generation is huge is that they're throwing money away. You want to make sure that the investments that they're making make sense. You want to give back to shareholders who invest and believe in you."

Tasho manages the Aston/TAMRO Diversified Equity Fund ( ATLVX), which has about $18.4 million in assets as well as $11.6 million in individually managed accounts. Of that $30 million, 2.3% is devoted to Google, Tasho says, because he looks past the company's spending and realizes the strength of what Google has to offer with its search business.

The search advertising business accounts for 90% of Google's overall revenue, and the company continues to gain market shares. According to ComScore data, Google's share of the search-engine market rose to 66.6% last month from 66.2% in November. Yahoo! ( YHOO), on the other hand, saw market share fall to 16% from 16.4%.

"While people may complain that Google is a one-trick pony, it's a great one trick," Tasho says. "They dominate search. The first thing people do when they go on the Internet is search. This company has been able to maintain a huge market share over everyone else. And they find new and unique ways in which to continue to attract users."

Dodson, manager of the Parnassus Workplace Fund, also finds value in Google's search business. As of Nov. 30, Google represents the third largest holding in the fund with a weighting of 4.6%, behind only Qualcomm ( QCOM) and eBay ( EBAY).

"A lot of the other businesses Google has started haven't done as well, but we think the search business is very good," Dodson says. "They have such a large market share, it's not going away. As the economy is growing, more people will use the search function. Also, we think there is upside with the Android operating system. Those are the two key drivers. That's why we like Google from the business standpoint."

Dodson purchased Google for the Parnassus Workplace Fund as it fits the selection criteria the fund has laid out. In addition to meeting certain financial metrics for valuation, Google is "a very good place to work," Dodson says. The philosophy behind the Parnassus Workplace Fund is that companies with favorable workplace environments lead to positive-minded employees, better retention and productivity.

When it comes to Google's across-the-board pay increases, Dodson quickly dismisses concerns, arguing that the 10% rise in salaries is "relatively modest" and likely won't affect the company's bottom line.

"Many of their employees were being hired away by Facebook and others. They needed to do something for retention," Dodson says. "The other issue, which a lot of people don't understand, is that the cash portion of Google's salaries are not that high. They're pretty much in line with the market. That's why a 10% increase in cash is not that destructive to the bottom line. It's the stock portion and options that is more of a concern."

However, Dodson and Tasho are split on their view of Google's potential upside. Dodson says the Parnassus Workplace Fund has an average cost for Google shares of $450. "It was a very good value in terms of price, and it has appreciated quite a bit," Dodson says. "At $630, it's probably not a great bargain today even though we think there is more appreciation."

Dodson notes that while Google faces some competition in the search business from Yahoo and Microsoft ( MSFT), the bigger competitive threat comes from the Apple iOS against the Android mobile operating system. Even so, he says the potential rewards outweigh the risks.

"Right now, I'd say there is greater upside potential than downside potential, which is why we're still holding on to it," Dodson says. "But we liked it better at $450 than $630."

Tasho, on the other hand, says he sees at least five times greater upside than downside for Google, which would put his upper target limit close to $1,200. For Tasho, this view is strictly based on valuation.

"The valuation is very attractive for us," he says. "Google hasn't quite regained its footing, as concerns about China and whatnot have weighed on the shares. With Google, we are valuing the company on sales. It has a squeaky-clean balance sheet. And their downside is relatively modest. But to achieve, we need to have confidence Google will continue to execute as we saw in the last quarter."

Analysts are similarly bullish on Google shares. Thirty-seven researchers have a "buy" rating on Google shares, with another seven saying investors should hold on to shares. The average of 28 recent price targets from analysts is $693, which represents nearly 10% upside potential.

TheStreet Ratings has a "buy" rating on Google with a price target of $712.28, thanks to "robust revenue growth, largely solid financial position with reasonable debt levels by most measures, impressive record of earnings per share growth, compelling growth in net income and reasonable valuation levels."

What investors may ultimately come back to, though, is Google's dominance with Internet search. "Search is really everything to this company, and they want to continue to expand their reach to users," Tasho says. "Display advertising is one way of doing that. The other is the Android operating system. The growth of mobility is just enormous globally. You can't underestimate that."

And when it comes to employee raises, fund managers like Tasho expect that investors will appreciate what the Google is doing as things play out.

"You want to encourage technology companies to invest in R&D and new ventures. You want to maintain that culture of entrepreneurship," Tasho says. "Not everything is going to fly, but focus on the trends that are resonating out there."

-- Written by Robert Holmes in Boston.

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Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.

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