Fans Gape at Google

The lovefest resumes following a blowout first quarter.
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The law of large numbers worked in

Google's

(GOOG) - Get Report

favor this time around.

Shares of the search engine soared to three-month highs Friday after the company

posted first-quarter earnings that were light years ahead of investor expectations. The breakneck pace of the company's growth wowed Wall Street analysts, many of whom had begun to waffle a bit about the stock.

"The numbers, honestly, are at times unfathomable for us," writes Scott Devitt, an analyst with Stifel Nicolaus, in a note to clients Friday. He maintained his buy rating on the stock and upped his target price from $435 to $500. Stifel Nicolaus makes a market in Google shares.

"The question we have constantly struggled with in Google is, 'How big can this thing get?'" Devitt adds. "We do not have a good answer for the question."

Friday's 7% jump put Google shares back above $440, a level they hadn't seen since January's fourth-quarter earnings debacle. Back then, Google blamed taxes, the law of large numbers and all manner of other factors for a stunning 24-cent earnings shortfall.

This time around, Google beat Wall Street's target by 31 cents, so no excuses were necessary.

Still, some observers turned a skeptical eye on the company's cost control, noting that latest-quarter expense growth at 86% outstripped even Google's torrid revenue expansion of 79%. Chief Financial Officer George Reyes said during the earnings conference call Thursday night that costs will continue to rise sharply.

"It's already spending more than twice the level of

Yahoo!

(YHOO)

," says Darren Chervitz, director of research at Jacob Asset Management, which holds Google shares.

"Of course, it's generating almost twice the cash as well" if you look at earnings before taxes, depreciation and amortization, he adds. "But you do wonder whether it will be able to manage all the growth and rising costs effectively."

For now, the worries about Google are being placed on the back burner as Wall Street tries to figure what's next for the search engine giant. That's going to be difficult. Analysts were expecting a profit of $1.98 a share on net revenue of $1.44 billion in the first quarter, according to Thomson Financial. Google reported earnings of $2.29 and sales of $1.53 billion.

The earnings surprise pushed Google's shares today as high as $450.72, their highest level since Jan. 27. They last traded at $442.95.

Even Merrill Lynch, which has long been skeptical about Google, is joining the bandwagon. Analyst Justin Post today upgraded the stock from neutral to buy and slapped a $540 price target on it. The investment bank makes a market in Google shares and has provided the Internet company noninvestment banking services in the past 12 months.

"We expect Google's advertising share growth to continue, and Google's innovation is expanding the online ad market," he writes. "Google's consumer offerings sell themselves with marketing costs at just 12% of revenue."

Merrill's target is 44 times its 2007 earnings forecast of $12.25 or 35 times its 2008 EPS forecast, "a reasonable price for the Internet industry leader with 44% three-year growth expected from 2005 to 2008," Post says.

Google is continuing to expand internationally, add new features such as a digital calendar, and improve its free listings service Google Base. The company, which went public in 2004, had 6,790 workers at the end of the first quarter, up 19% from the end of last year.

The appetite for Internet advertising is showing little signs of slowing. Web Advertising revenue rose 30% last year to $12.5 billion, according to data from the Internet Advertising Bureau, a trade group.

"As a result of Google's positive earnings and the IAB report, we are expecting a strong quarter from stocks in our Internet sector and those that have advertising revenue," writes WR Hambrecht analyst Denise Garcia, who rates the shares a buy and boosted her 2006 and 2007 earnings estimates, in a note to clients.

Internet advertising and marketing firms

aQuantive

(AQNT)

,

Digitas

(DTAS)

,

Marchex

(MCHX) - Get Report

and

ValueClick

(VCLK)

will meet or beat expectations when they report earnings starting April 27, Garcia predicts. Her firm makes a market in shares of Google, aQuantive, Digitas and ValueClick.

To say Google's shares have had a bumpy ride may be an understatement. In its first 16 months as a public company, the Mountain View, Calif., Internet search giant could do no wrong. Google shares doubled in 2004 off their initial public offering in August of that year, and then doubled again last year. The stock soared through the first half of January this year, touching $475 at one point.

Then, Google showed signs of being mortal. It disappointed investors in the fourth quarter. Then came a series of embarrassing investor relations gaffes that pushed down the stock further and unnerved Wall Street.

Analysts started fretting about Google's growth prospects and wondered if growing competition from the likes of

Microsoft

(MSFT) - Get Report

would slow it down. Now, instead of worrying about Google, they are trying to understand where it can grow from here.

Though investors are back on the bandwagon, Google appears to be trying to improve communications. Chief Executive Eric Schmidt even asked analysts about the earnings conference call.

"Our efforts to achieve greater transparency apply to a variety of our key audiences including but not limited to shareholders," says Jon Murchinson, a Google spokesman, in an email. "We think it is in our best interests as a company to communicate more about what we are doing and why on topics such as our products, public policy issues and finance."