Some Google (GOOGL) - Get Report analysts are raising their price targets slightly because the higher costs that drove earnings down are expected to abate. But some analysts see Google as closer to a growth stock than the market gives it credit for.
Morgan Stanley analyst Brian Nowak wrote in a note after the search giant's third quarter earnings that there are "several underappreciated" growth drivers for Google. Meanwhile, Google had its "staple-like ecosystem on display," Nowak said, referencing the way some are now thinking about the stock. As search and advertising revenue decelerates from its previously rapid growth rates, and in the absence of a new driver of high growth, many are now wondering if Google should be viewed similarly to a low-growth but stable consumer staple. After all, the stock now trades at a historically low price-to-earnings multiple of 22.7.
But Nowak says Google still has something left in the tank.
Before we dive into that, here's why Google's earnings miss still had analysts raising price targets.
Google's revenue of $40.5 billion beat estimates of $40.3 billion, while higher-than-expected costs caused EPS to come in at $10.12 versus estimates of $12.32. But analysts noted most of those costs were either non-recurring or initial operating investments that won't continue to grow much from here. Those include a one-time $550 million settlement in France, a $1.5 billion paper loss on equity investments in start-ups and a wave of new engineer hires. Meanwhile, search, YouTube and cloud revenue beat expectations. This all paints a positive earnings picture in the future.
Those who say Google is starting to look like a staple or utility point to decelerating revenue growth that may sit at below 15% after 2021. Search revenue will always be there and grow modestly. Earnings growth is on a similar path, and could only grow by 8% in 2021. Nowak pointed even said "We estimate Google's $40 billion plus annual, 20 year-old desktop search business grew 4% year-over-year in the third quarter." That's not a very exciting growth rate.
But that result came "with the company calling out verticals like travel and insurance which still do well in desktop," Nowak said. Moreover, "We see this innovation led growth continuing...and we see the potential for Maps, Discover, and Google's new e-commerce products to potentially add $5 billion of annual revenue alone. Will it all come in 2020? No, but in our view these types of products (and Google's continued focus on user and advertiser innovation) are what enable them to deliver this robust growth for the long-term."
Nowak values Google at 34 times EPS for the next 12 months through September 2020. Adding to his thesis, Nowak noted that Google's current valuation is 25% under that of a typical consumer staple, even as Google can grow five times faster than those companies. Importantly, many have viewed staples as relatively expensive of late.
Nowak's $1,450 price target on Google reflects 14% upside, but it's not clear he's modeling in all of the growth he projects. Much like the case for Facebook (FB) - Get Report , some analysts see room for growth on many developing platforms Google creates, but hesitate to account for every potential future dollar of earnings until they see evidence those dollars will flow in.