Regular readers of this blog know that sell-side analyst research reports are not something I reference very often for trading recommendations. The numbers show that analyst picks fail to beat the market consistently, and do so with more volatility, just as most mutual funds do. That said, given that most Wall Street research is positive in nature (they want you to buy stocks, after all, so they make money) there will be a lot of times that I agree with the analysts, merely due to probability.
In May I wrote positively about search giant Google (GOOG) when it was trading in the low 460’s (Google Looks Cheap, Believe It Or Not). At the time I wrote that upside to $600 per share looked like a conservative price objective, with downside limited most likely to only $450 per share. This view was also the consensus view on Wall Street, with most analyst price targets right around $600 per share.
Well, the analysts got it right this time, so let’s give them credit. Google crossed $600 per share this week, jumping $5 yesterday to reach an all-time high of $615 per share. In doing so, Google now has a larger market value ($192 billion) than Wal-Mart (WMT) ($184 billion), a fact that many seem to find pretty staggering. I want to make two points about this in justifying why investors should not be alarmed by recent trading action in Google stock.
First, the reason why we see analysts now raising their price targets on Google closer to $700 per share is due to the fact that 2008 earnings estimates are approaching $20.00 per share (As I predicted in May) and the company’s growth rate should be in the 30 percent range for the next several years. Most any investor will tell you that a P/E equal to or slightly above a company’s growth rate is fairly common.
A conservative valuation on Google of 30 times earnings gets you to $600 per share, and a P/E of 35 or 40 for one of the world’s fastest growing companies is a price tag that many investors will be willing to pay, hence the rising price objectives. Personally, I would not be loading up the boat on Google at current prices, but a trading range of $500 to $700 per share over the next six months or so seems reasonable. Given we are right in the middle of that range right now, Google shares are a solid hold, with a bias toward profit taking over purchasing if a trade needs to be made.
As far as the Wal-Mart market value comparison goes, the discrepancy that might seem overdone to the casual observer really isn’t out of whack with reality. In 2008, Google is expected to earn a profit of $6.1 billion, which is less than half of Wal-Mart’s expected net of $13.8 billion. This implies a P/E on Google of more than double Wal-Mart, which is the case (31x vs 13x forward earnings). However, given that Google’s margins and growth rates are far higher than the world’s leading retailer, investors can easily justify the market values of both companies. That said, Wal-Mart appears to be the better value, trading at a below-market multiples, versus 2x the market for Google.
Full Disclosure: Long shares of Google at the time of writing