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Google (GOOG) Still Looking Good

 October 17, 2011 11:30 AM

Google (GOOG) reported better than expected third quarter earnings of $9.72. Consensus was $8.74. Revenue growth of 33% slightly exceeded consensus estimates. The EPS beat was helped by other income, foreign exchange, and a lower than expected tax rate but this quarter revealed again that GOOG's core organic growth is not slowing down. Given the low P-E of 1 times 2012 earnings excluding over $130 in cash, the growth rate is what matters. This marks the fourth consecutive quarter of accelerating growth for GOOG. The stock is too cheap, even after the big run into earnings and 7% rise after the report. A target over $700 is easily achievable if the economy and market hold together and GOOG tracks to current 2012 estimates.

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Also encouraging was stable sequential margins. GOOG is tightening its expense growth and it appears that margins may have bottomed in the second quarter. Margin expansion is the big missing piece for GOOG shares. The company continues to invest heavily in mobile, display, Chrome OS, and the Chrome browser. Management commentary indicates that these investments are paying off on the top line. At the same time, products are being dropped so the focus of the heavy investment is on areas that can make a difference.

Closing of the Motorola Mobility (MMI) will dramatically impact financial results in 2012 due the large revenue it brings. GOOG needs to further improve its financial reporting and transparency so core growth in search, mobile, and display is apparent. GOOG also faces tougher comparisons beginning next quarter which could limit reported growth.

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Despite these issues, investors should stay focused on top line growth ex MMI and margins. The last few quarters these issues have been in the right direction. I think it is time to believe that GOOG can sustain 20% growth at stable margins. If so, the shares have a lot of upside. I am a believer.

Disclosure: GOOG is widely held by clients of Northlake Capital Management, LLC, including in Steve Birenberg's personal accounts. Steve is sole proprietor of Northlake, an SEC registered investment advisor. GOOG is a net long position in the Entermedia Funds, long/short equity hedge funds focused on media, entertainment, communications, and related technologies. Steve is co-portfolio manager of Entermedia, owns a stake in Entermedia's investment management company, and has personal monies invested in the Funds.



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