Google Inc.'s 77-per-cent surge in second-quarter profit has confirmed its stranglehold on the search engine market, at least for the foreseeable future. But some analysts and investors fret that the juggernaut's greatest strength, its dominance of the paid search market, has become its greatest weakness.
The Mountain View, Calif.-based company's stock is down 7 per cent so far this year, but at $382.77, it still trades at nearly 40 times estimated 2006 profit. But the U.S. economy is slowing and central banks around the world are raising interest rates to cool their own, and that has some investors wondering how well Google can weather an economic downturn.
"The thing that keeps me from buying more is a worry about a recession and worry about how they make it through, and the movement of people away from away from high-multiple stocks," said Walter Price, who handles $2-billion (U.S.) at RCM Capital Management, a large part of the portfolio being Google shares. "The thing that keeps me invested in it is it has a very high growth rate, which I think will be maintained. . . . Obviously, if we have a recession, all bets are off."
But, Mr. Price said he expects current growth rates to continue at 30 to 40 per cent for at least the next three years and that matches the consensus among analysts.
"They're not only gaining share in search queries, but they're also gaining share in terms of revenue per search page," said Paul Cheung, an analyst at CIBC World Markets. He is projecting earnings per share to jump to $12.53 in 2007 from an estimated $9.45 this year.
Most analysts have a "buy" recommendation on Google's stock. The search engine now accounts for roughly 62 per cent of all Internet searches. It nearest competitors, Yahoo Inc. and Microsoft Corp., account for roughly 20 and 9 per cent of searches, respectively.
Google gained further ground after Yahoo announced a delay in rolling out its new ad software when it announced its own, more modest second-quarter earnings last week. The lack of multiple revenue streams may hamstring the company, however.
"It is going to be a problem because there are things such as click fraud or even larger economic issues that could get in the way of these huge quarter-by-quarter reported earnings," said David Hallerman, senior analyst for eMarketer, a U.S. e-commerce analysis firm. "There are some definite warning signs out there."
That's why Mr. Hallerman was impressed that Google's research and development budget for the second quarter continued to increase, up 15 per cent from the previous quarter. "They have the money and they keep putting it back in," he said. "If you throw enough mud, soon enough it will stick."
Mr. Hallerman admits that nothing has stuck yet for the company aside from search ads, but he expects the company will make gains in something technology-based, such as video or mobile searches.
The pace of on-line ad sales growth is expected to peak for the decade in 2006, at roughly 33 per cent, for a total of $16.7-billion in sales, Mr. Hallerman estimates.
Google could hold 54 per cent of the $6.4-billion search market by the end of the year, up from just over 18 per cent in 2001, according to eMarketer. An Internet Advertising Bureau study projected on-line ad sales in Canada to hit $801-million (Canadian) this year, up 43 per cent from 2005.
Investors like Mr. Price have little worry about competition from within the search engine market, but said he was less impressed by the potential for Google to dominate the video market or its recent venture into banner ads because of the "steep learning curve" the company faces in developing a competitive product. He said the company's greatest potential for additional revenue lies in mobile searches.
Philip Remek, an analyst for Guzman & Co., was one of the only analysts last week who said Google's stock is an "underperform."
"It's already built into the price that they're going to have a very high growth for a long time. There's just no room for error. I don't think that's a reasonable expectation for any company," Mr. Remek said.
While most analysts are predicting Google's target stock price to be anywhere from $450 (U.S.) to $550 by year-end, Mr. Remek is predicting Google's price will remain at $390.
"With each emerging technology there's often a bit too much hype about the industry's prospects and that hyper-growth rates can continue indefinitely and they don't," Mr. Remek said.
