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The Google Stock Conundrum

The stock might be inexpensive, but it also has limited upside


What’s an investor to do with Google (NASDAQ:GOOG)?

The stock is down more than 12% from its high of late March and it is trading at the low end of its historical valuation range — 17.4 times trailing earnings and 11.4 times forward estimates. The last time Google plumbed these valuation depths was during the crisis periods of late 2008 and early autumn 2011, and it staged a robust recovery along with the broader market on both occasions.

Unfortunately for longs, this hasn’t been enough to entice buyers.

The problem with Google is rising competitive pressures outside of its core search business. So far, 2012 has brought far too many negative headlines for the company, including:

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And while not directly affecting the business yet, concerns about the company’s privacy practices — and the constant drumbeat of criticism from the Drudge Report and others on that score — isn’t helping the cause. Put it together, and you have a stock that has lagged the broader sector — as gauged by the Select Sector Technology SPDR (NYSE:XLK) — by a wide margin so far this year.

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Google also hasn’t provided any excess returns in a five-year basis despite several periods of outperformance along the way.

Even with the various headwinds weighing on the stock, analysts are looking for EPS growth of 20% this year and 16.3% in 2013 — healthy gains for any company, but particularly one of Google’s size.

However, a look at the chart of the company’s P/E ratio and earnings growth rate shows a gradual decline from a premium price/earnings-to-growth ratio to one that is at or below 1. Google’s PEG is just 0.73, which places it below other mature large-cap tech stocks such as Microsoft (NASDAQ:MSFT, 1.07), Intel (NASDAQ:INTC, 0.92), Cisco (NASDAQ:CSCO, 1.07) and IBM (NYSE:IBM, 1.15).

Why the valuation contraction? David Klaskin — the chairman, chief executive officer and chief investment officer of Oak Ridge Investments in Chicago — offers this explanation:

“Google used to be the best play among a small group of Internet stocks because of its recurring revenues, but as time has gone on and other companies have moved into various aspects of the business — such as cloud computing — the stock became less essential to own. We still like the core search business, and Android is competitive. But one important problem is that the purchase of Motorola Mobility has brought Google into the manufacturing side, with the fixed costs and risks that go along with that. Even if they execute, the stock will probably trade at a lower multiple now — and it’s less likely it can benefit from significant multiple expansion going forward.”

As a result, it seems that there is little in the way of a catalyst to propel the stock beyond the $630-$660 range — where it has met resistance seven times since the beginning of 2011 from its current price near $570. What’s more, the five-year chart shows the stock nearing a lower trendline that terminated at $540 as of June 15. Below that, a more recent lower trendline provides some support at $508. A huge breakdown is unlikely — barring a crisis — given that a move to these levels will put the stock into uncharted territory in terms of its valuation. Still, Google’s proximity to these trendlines indicates that the risk/reward trade-off isn’t particularly compelling despite the stock’s poor recent performance.

As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media,

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