Don't Count Out Google the Innovator

BOSTON (TheStreet) -- Internet-search leader Google (GOOG) will announce its second-quarter earnings today. Under the new leadership of co-founder Larry Page, who replaced Eric Schmidt as chief executive officer in January, the company has continued to innovate. It recently field-launched Google+, a social-networking platform designed to poach users from privately-held Facebook. Google+ received positive reviews and demand from test users.

Google's growth trajectory has remained impressive over the past three years. The company has grown sales and net income at annualized rates of 20% and 23% during that span. Its stock, however, is almost unchanged. Large-cap tech stocks, even those of darlings Google and Apple ( AAPL), have hit roadblocks, despite historically cheap valuations and outstanding prospects. Google is both cheap and safe. It trades at a forward earnings multiple of 14, a book value multiple of 3.6 and a cash flow multiple of 15, 53%, 56% and 29% industry discounts. The balance sheet holds $37 billion of cash and securities and just $3.2 billion of short-term debt.

Analysts forecast, on average, $7.83 of adjusted per-share earnings for the quarter, a 37% year-over-year increase. But, they expect sales to have declined 3.7% to $6.6 billion. Google shares have dropped 8.7% in 2011, lagging the Nasdaq, which has advanced 6.4%. Researchers remain decidedly bullish on Google, despite this poor showing. Currently, 35, or 83%, of analysts evaluating Google rank its stock "buy." The remaining seven rate it "hold." None advocate selling the stock. Jefferies ( JEF) is the most optimistic forecaster on Wall Street, predicting that Google's stock will appreciate 48% to $800 over the next 12 months. Its investment thesis is multi-faceted.

Jefferies expects the second quarter to demonstrate growth, "reflecting healthy demand for search advertising and lower margins from increased investments. Litigation, anti-trust investigations and margin concerns may continue to weigh down the stock." This quarter, U.S. dollar weakness should offer a tailwind to results, as the greenback has fallen by 1.6%, sequentially, and more than 50% of Google's sales are now generated in foreign markets. Currency hedging may offset this potential profit boost. Interestingly, Jefferies, despite having the highest price target on Wall Street, expects revenue of $6.5 billion to miss consensus.

The bank believes that "a pull forward of domestic demand" in the first quarter and macro concerns in Europe, Middle East and Africa businesses may have decelerated regional growth in the second quarter. Jefferies remains attracted to Google's reasonable valuation and dominant market share, at roughly 70% of global search. On Tuesday, ComScore released its search-market figures, which indicated that Google, Microsoft ( MSFT) Bing and Yahoo! ( YHOO) each retained a comparable slice of the search pie, relative to first-quarter proportions. Query growth decelerated, but remained in solid positive territory.

Google, specifically, grew queries by 7.5%, less than the 9.7% expansion of the first quarter. While ComScore's data indicated 67% market share for Google, it does not account for mobile search or video search on Google property YouTube, perhaps the second-largest search platform. ComScore only incorporates desktop search. Some analysts, attempting to quantify all search platforms, estimate Google's market share to be as high as 97%. Google's Android software now powers 38% of smart phones, according to Jefferies. In sum, while Google's growth appears to be tapering in its bread-and-butter business, emerging properties are still accelerating in usage, providing a boost to sales, going forward.

Jefferies' channel checks suggest improved cost-per-click pricing and higher click-through rates, major determinants of Google's margins. During the first quarter, Google's gross margin widened from 69% to 70%, but its operating margin narrowed from 37% to 33%. Google is in rapid expansion mode. It has recently amplified hiring and investment plans, a move that Jefferies names as a potential margin headwind. In addition to Google's effort to square off with Facebook via Google+, it is preparing to contest the dominance of Netflix ( NFLX) in streaming movies and Amazon ( AMZN) and Apple in book downloads, all through a revamped Android Markets, its mobile digital store.

The revamp was announced shortly after Netflix announced a bump in its prices, which is irritating consumers. Notable short-seller Whitney Tilson of T2 Partners, though he lost money on his short, did accurately forecast the inevitability of this move. Netflix's price hike may present an opportunity for market-share gains for Google. Also, the Google eReader, called iRiver Story HD, is due this month. It will be sold online and at Target ( TGT).

-- Written by Jake Lynch 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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