How High Can Google Go?

Shares of Google (GOOG) jumped 12% to an all-time high of $339.90 Friday after the Internet giant blew away Wall Street's third-quarter estimates with a sevenfold surge in profits and a doubling of sales. Analysts tripped over each other in the rush to issue the rosiest research report. Lehman Brothers, First Albany and RBC Capital Markets each lifted their 12-month price targets to $450, despite the fact that the stock has already gained 76% year-to-date. The exuberance was reminiscent of the famous call in 1998 by Blodget, then an analyst at CIBC Oppenheimer, who predicted that Amazon.com (AMZN) would jump from $230 to $400 within a year. Less than a month later, it did.

"Google posted a phenomenal quarter, period," wrote Lehman Brothers analyst Douglas Anmuth, who reiterated his Overweight rating and increased his price target from $350. "The earnings potential in Google's model is very powerful.... The company is monetizing well, rolling out innovative new products, taking search market share, and expanding internationally in an overall market that is still in its early days. We believe Google is hitting an inflection point in its business as evidenced by improved monetization; the shift of revenues to Google-owned sites; and greater traction with branded advertisers." (Anmuth doesn't own shares of Google; Lehman Brothers has an investment-banking relationship with the company.)

Based in Mountain View, Calif., Google late Thursday reported third-quarter profits of $381.2 million, or $1.32 a share, compared with $52.0 million, or 19 cents, in the year-ago quarter. Excluding one-time expenses and stock-based compensation, adjusted earnings were $1.51 a share, topping the Thomson First Call consensus estimate of $1.36 a share by 11%. Revenues rocketed 96% year-over-year to $1.58 billion.

"To say Google's quarter was jaw dropping is an understatement," wrote Jason Avilo, an analyst at First Albany, who reiterated his Buy rating and boosted his target price from $363. "The company accelerated revenue growth on Google.com to 115% year-over-year in a seasonally weak quarter." (Avilo doesn't own shares of Google; First Albany doesn't have an investment-banking relationship with the company.)

The company said sales at Google-owned sites grew 20% from the second quarter to $885 million, or 56% of total revenues. Google Network Revenues, generated on Google's partner sites through AdSense, contributed 43% of total revenues, or $675 million, a 7% increase over the previous quarter. International revenues contributed 39% of total revenue, compared with 39% in the second quarter and 35% in the same quarter last year.

Traffic acquisition costs, the portion of revenues shared with Google's partners, totaled $530 million, or 34% of advertising revenues. Google attributed its growth to continuing to expand its global advertiser base and partner network, as well as product improvements. Operating margins, or operating income as a percentage of revenues, was 33.5%, compared with 37.8% a year ago and 34.4% in the second quarter.

"The story was higher than expected top-line and bottom-line growth, especially in a quarter that trends toward the lower end of normal seasonality for paid search," wrote Citigroup analyst Mark Mahaney, maintaining his Buy rating and raising his price target to $430 from $375, based on 42 times his "conservative" 2007 pro-forma earnings estimate of $10.37. "What's especially impressive is that this growth is all organic. And what may be most impressive is that this growth is occurring with what we view as still limited contribution from new products like Gmail, Google Local, Google Maps, and now, Google is entering its seasonally strongest quarters — December and March." (Mahaney doesn't own shares of Google; Citigroup has an investment-banking relationship with the company.)

The widespread enthusiasm about Google's third-quarter financials largely drowned out the caution expressed by a minority on Wall Street.

"We continue to believe that Google is an outstanding company with very strong management," wrote Legg Mason analyst Scott Devitt, in a note maintaining his Hold rating. "However, we hesitate to recommend purchase of Google shares at current levels, as we believe the shares do not fully reflect the long-term competitive threats.... We continue to believe eBay (EBAY) and Yahoo (YHOO) represent better long-term investments at current levels." (Devitt doesn't own shares of Google; Legg Mason doesn't have an investment-banking relationship with the company.)

Google went public on Aug. 19, 2004, at $85 a share. Its stock has skyrocketed 300% since.

"Google shares are getting more interesting at these levels given its tremendous revenue and earnings momentum," wrote Merrill Lynch analyst Lauren Rich Fine, in a note reiterating a Neutral rating. "As we have raised our estimates quite a bit, we see some upside in the shares but not enough to cross the 20% threshold required for a Buy rating. We are increasingly less convinced that Google shares should trade at a discount to Yahoo, but still see risk with lower visibility into the ongoing performance of the business, a less seasoned management team, a relatively undiversified revenue stream, and rising performance expectations." (Fine doesn't own shares of Google; Merrill Lynch has a non-investment-banking relationship with the company.)

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"This quarter, yet again, showed there is room for Google to grow," says David Edwards, an analyst at Greenwich, Conn., research house American Technology Research, who raised his price target to $400. "The net revenue is what people focused on. It has been growing at more than 100% for five straight quarters. The only quarter it grew 97% year-over-year was June 2004, and earnings are growing even faster." (Edwards doesn't own shares of Google; American Technology Research doesn't have an investment-banking relationship with the company.)