Time to take a small dip: GOOG

After the last weeks sell off, I believe there are some great opportunities. I snagged Google (GOOG) and Goldman Sachs (GS) last week as they have fallen hard and oversold. Before you read forward please note the following two points.

First, I took a dip as I was going to be busy next couple of weeks and would miss the opportunity. These are investor darlings and will not stay at bottom for very long and I am not an expert to time a perfect bottom. "If this is not the bottom, it is very close and I am willing to hold these for about a year and reap profits :)" Second, I mentioned dip I bought 8 GOOG and 10 GS shares. It is not a dive, just a small dip ;) Let us move to my rational behind these buys.

GOOG: I said "I would not touch google above 420"

Google is currently selling at 438.68. Analyst expect google to produce 2007 EPS of 13.56 - 15.49 with a median of 14.25. That gives Google a forward P/E of about 30 (Compared to Yahoo 54). I have told many people to wait for GOOG to reach 420 before you get in, but I did dive in with 8 shares as I might be busy next week to get in at the right price. Also, being GOOG, one of the most followed stock, people with get in there as soon as it touches the P/E of 30. So, it is not going to stay there for long.

Compared to their 2008 EPS, GOOG is almost 23 times earnings. With a growth of 40% in 2007, this is one of the very few times that you will have PEG of 0.95 (less than 1:). Yahoo has a PEG ratio of 2.19. So, let me back up a little - Leadership position in searches, great core product , gaining market share means stock should be cheaper. Isn't that what market is saying?

Lets look at the earnings growth opportunity. First their core busienss, search advertising. Google is still gaining market share. On top of that they have the best monetization rate of the searches based on a better algorithm. That is a double whammy.

On the content side, Google adsense still doesn't have any competition. The beauty of adwords is in the problem that it solves. There are tens of billions of website on wide variety of topics. If you are a big firm and you have your own advertising group that monetizes the spaces on your website. What about a small guy, who just has a small blog about dogs or guitar or investing:) How do you monetize the ad space on your website with out spending disproportionate amount of time on trying to target advertisers? Answers is simple - Google adsense. It generate s advertisements dynamically based in content of the site.

Finally, in next 18-24 months, some of the initiatives in the pipeline will start to trickle down to the pipeline. Google have been secretly working on a number of initiatives that can be categorized into

1> Small Business services - Google docs & spreadsheets,
2> Consumer services - maps, book scaning et all
3> Mobile inititaives - They have acquired a number of mobile software firms

These initiatives are equivalent to the drug pipelines of pharmaceutical firms and will keep the earning growth going.

So it's a great company with lots of growth, but can I make money on the stock? Let's assume that google is able to maintain it's EPS in 2007 and at the current PE of 40 for a growth company gives us a valuation of 570 in 2007. Also, if the company doesn't reduce it's earnings forecast. Based on a forward PE of 30 we get a valuation of 555.

Now Google has always blown the estimates except one quarter last year. And if they are able to deliver beyond the target.

As with any stock there are risks to this rosy picture. But, the risks are few and limited.

1> Google may not achieve these growth rates. In fact, with Panama success for Yahoo we may see yahoo capturing more of the incremental ad revenue that their current share. I believe, Panama, if successful, will not be monetized before 2008 and 2009. The current advertisers will stick to tried and tested google adwords and wait for at least a year to confirm the success of Panama.

2> The whole internet advertising may slow down. This is very likely if we get a hard landing and companies reduce advertising expenses. I believe that even in this case, GOOG is the stock least likely affected and money will move out of other search competitors first. Also, I don't believe in Hard landing just a slowing with may be one quarter of GDP contraction.

Loading Dock: anything below 420-440
12 months Target: 540
Return expected 25%

Tomorrow I will write a post about GS, but here are the price

Loading Dock at anything below 200
12 months target: around 260
Return expectation: 30%