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October 29, 2013

Google Finally Provides Upside That Triggers Shares

Google (GOOG) finally reported a quarter that surpassed Wall Street estimates and satisfied investors. The stock had worked higher over the last few years despite never quite satisfying Wall Street. A bull market and solid core growth search carried the stock but it lacked the momentum of other high flyers with which it is often compared. Linked In, Netflix, and Facebook all produced stock gains well ahead of GOOG.

I continually stuck with GOOG for Northlake clients because I found the consistent 20% growth in the core online advertising business to be undervalued by investors. The stock was stuck between $850 and $900 from May until this month’s earnings report. Facebook, LinkedIn, Netflix, and Priceline rose between 30% and 100% over the same time frame. Despite what I thought was steady progress for GOOG on the earnings and business development front, it had become clear that the company needed to beat the street to free the stock to realize the potential I thought existed.

Well, that finally happened with the third quarter report. GOOG beat estimates. Most importantly, revenue trends remained at the 20% plus level for the core but margins showed upside to street expectations. If there was one thing that had been troubling GOOG shares, it was steady deterioration in operating margins as the company diversified and transitioned its business model to a mobile world. Upside in the third quarter margins excites investors and is leading to multiple expansion. The shares moved from $890 just prior to the report to the current $1,028 which is right at an all-time high.

Looking ahead, GOOG shares are trading about 20 times Wall Street estimates for 2014, which call for 18% growth. The company has about $43 billion in cash net of debt, representing about $130 in cash per share. I think the company deserves some credit for the cash, so you could argue the 20 P-E overstates the value by 1-2 multiple points.

I think the shares can rise another 20-30% if the GOOG shows that it can more regularly beat earnings estimates. The company is very hard to model and management provides limited guidance and really does not seem to care that much about quarterly results. GOOG truly does seem to be run for the lng-term.

If GOOG hits 2014 estimates for $52 in earnings I think the multiple can expand slightly driving the shares to $1,200 or up another 20%. There are very few megacap stocks grow anywhere near 20%, high single digits is good for most large cap blue chips.

If the company can string together a few better than expected quarters, Wall Street will start looking toward 2014 EPS of $54 or $55 and apply a higher multiple as fears about margins recede. This would put a bull case for the stock closer to $1,400 based on a 24 multiple and credit for the cash.

As long as GOOG sustains core growth near 20% and shows discipline on operating expenses, I think the shares will have enough upside to justify them as a core holding in Northlake client portfolios.

GOOG is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg’s personal accounts. Steve is sole proprietor of Northlake, a registered investment advisor. GOOG is a new long position in the Entermedia Funds. Entermedia is a long/short equity hedge fund focused on media, communications, leisure, and related technologies. Steve Birenberg is the portfolio manager of Entermedia, has personal monies invested in the funds, and controls Entermedia’s General Partners.

Posted by Steve Birenberg at October 29, 2013 12:30 PM in GOOG