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Google Climbs CPC “Wall Of Worry”, But Less Attractive For Value Investors

 February 12, 2013 02:37 PM

() Search giant Google, Inc. (NASDAQ: GOOG) has climbed a major "wall of worry" over declining cost-per-clicks (CPC). At the same time, it is becoming less attractive to value investors due to its higher P/E multiple and lack of shareholder returns.

Let's dig in to the CPC part first. Google's revenue is measured by two key metrics - paid clicks and cost-per-click (CPC). Paid clicks represent the traffic for a sponsored link, while CPC is the amount that an advertiser pays to Google each time a paid click occurs.

Investors and Wall Street alike focus heavily on CPC because Google's revenue is directly impacted by this metric. More than that, it shows the appetite of an advertiser to put ads on Google. If Google's CPC is declining, it suggests that advertisers are cutting their budgets since Google is an indispensable part of the industry.

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The most important element of Google's fourth quarter earnings was the strength of the shares the following day despite the 6 percent decline in CPC. Google gained as much as $46, or 6.5 percent, to $749 on Jan.23, the day after its earnings report that also showed aggregate paid clicks rising 24 percent.

The strength in the shares shows that the market is now comfortable with the idea of secular pricing declines across online advertising. Since mid-June, Google has climbed a "wall of worry" as investors digest cost-per-click declines.

Moreover, investors need not worry too much about the decline in the CPC, which is closely related to the economy. When the economy improves, the number would increase.

[Related -Google Inc (GOOG): Why Nest Labs Deal Is A Wakeup Call For Apple Inc.?]

However, Google's margins continue to erode over time, and that there continues to be no return of capital to shareholders, making it less attractive for investors seeking returns in the form of dividend or share buybacks.

"As such, we believe that profile makes the shares compelling at or below market multiples (particularly to value investors), but much less so when forward P/E begins to approach the high teens," BMO Capital Markets analyst Daniel Salmon said in a client note.

In addition, the stock's forward non-GAAP P/E multiple has moved to 17 times from June 2012 levels of 12 times, making it less compelling opportunity for value investors.

"We see multiple expansion beyond the current level as a challenge. Our basic view of  Google as a 15%-20% top-line grower with gradual margin erosion is unchanged. Combined with a lack of share buyback or any other EPS growth accelerant, we believe this profile is much less compelling to value investors at 17x versus 12x," Salmon added.

That said, Google is still the bellwether online advertising company and that it can continue to generate 15 -20 percent revenue growth for the next three to five years, with an average earnings growth of 13.75 percent in the next five years. That is why 29 of the 38 analysts covering the stock rate it as a "strong buy" or "buy," while the rest recommend "hold."

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