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April 21, 2006

Google skeptic comes around

Tim Mullaney

A few months ago, Stifel Nicolaus analyst Scott Devitt took a turn in the spotlight for crystallizing skepticism about Google shares, which peaked in January around $475. Less noticed is that Devitt switched back to a buy rating once Google traded as low as $340. And today, Devitt responded to Google's strong first quarter by raising his price target to $500.

Money quote:

"The question we have constantly struggled with in Google is, 'how big can this thing get?' We do not have a good answer for the question but what we do know is that in the just reported quarter the company reported net revenue growth of 93% YOY, gross profit margin of 88%, EBITDA margin of 65%, and a cash operating margin of 58%. The company will generate more than $4.3 billion in EBITDA in 2006 and more than $2.5 billion in free cash flow. On 2007 estimates, Google now trades for 32x cash earnings while we expect free cash flow growth over the next three years to exceed 40%. We try to be conservative with our expectations for Google's non-search business but the current growth includes very little monetization from new areas such as video, local, wi-fi, mobile, etc. There may be a day when the previously stated question needs to be answered but it is not today and, as such, we are reiterating our Buy rating and raising our target price to $500 or 40x 2007 cash earnings."

I've been as active as anyone in the "what price Google" debate since it came out -- I was one of the few media bulls on Google's IPO. I've said it before and will say it again: 40 times earnings is not a lot (and at $450 the multiple is more like 36), and a PEG ratio of one is significantly cheaper than the S&P 500. As Devitt notes, you don't have to fall for all the breathlessness that pervades the press every time Google coughs. To make dough here, it simply isn't necessary for Google to take over every industry the idiots out there say it will, from travel to magazines to real estate (and that's just citing things I've read about in the last few months).

Google is a one-trick pony, and that trick is search advertising. For all its machinations, that remains true. But it's a hell of a trick, and it's a long way from saturated. And no matter how many times people from the noted financial centers we call the journalism reviews say otherwise, this thing is simply not priced for perfection.

There's a great backstory to the journalism-review post and its author, but it's off point here. Look over here for some hints.

08:21 AM

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Tracked on April 21, 2006 02:37 PM


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