Avoid These 2 Tech Stocks, Buy This Undervalued Gem Instead

By David Gould - October 19, 2012 | Tickers: FB, GOOG, YHOO | 0 Comments

• Email
• Print

While the Internet is always open to competition, there are some companies that are so well diversified across a variety of mediums  that risk is not much of a concern. There are, however, other companies where sustainability matters that have been pushed aside for a hyped-up long term view. Below, I review why I think Google will outperform Yahoo! and Facebook.

Google's (NASDAQ: GOOG) Synergetic Growth Potential Merits A "Buy"

Over the years, Google has done a great job of diversifying through various Internet mediums. While its Google+ social network has been almost entirely discounted by the market, investors should remember how quickly (and significantly) Gmail caught on a few years back. The integration of Google+ into search results, YouTube videos, Android mobile OS, and Gmail, among other things, makes one wonder why it has not caught on yet. However, timing can be very unpredictable with fads.

With that said, it should be noted that Google has a history of succeeding in innovation. It bought YouTube just when everyone thought it was overvalued and turned it in to a go-to site. It launched Android when everything thought it was Apple's iOS or bust and became the market leader.

And now it has launched Google X to convey this innovation through testing "pie in the sky" ideas that range from driver-less cars to virtual glasses. If there was ever one tech company to buy for coolness alone, it ought to be Google--not Apple. I believe that once the company starts to monetize the integration, investors and consumers will begin to appreciate the innovation.

Perhaps most importantly, Google has bested analyst expectations. In 2Q 2012, EPS of $10.12 was slightly ahead of the Street's $10.05 estimate. Revenue was up a stellar 35% year over year, driven largely by paid-click growth, and mobile search transitioned into positive territory. Even in the United Kingdom, where there is macro uncertainty, Google managed to deliver 22% year over year top-line growth. With over 400 million smartphones running on Android today, the potential to reach more consumers for ad revenue is very significant. All in all, Google controls a virtual economy that can be leveraged, even more than it already has, for continued growth. There's also the $35 billion in cash that the company can use for inorganic growth, like it did in the $12.09 billion Motorola Moblity takeover.

Yahoo! (NASDAQ: YHOO) & Facebook (NASDAQ: FB) Still Overvalued

After the successful management shakeup by activist investor Third Point, Yahoo! still looks relatively weak from a fundamental perspective. While the search business continues to become outdated, multiples are still relatively high. In addition to having a high bar set by analyst forecasts of 13.6% annual EPS growth, the stock trades at a respective 17.6x and 13.5x past and forward earnings. In many ways, it reminds me of Facebook.

Both companies are attempting to cling on to past glory. While Facebook may be fresher, it really is the same game: company launches new product, it catches on, product loses to new emerging entrants. Going forward, I am pessimistic about both companies. 

First, there's the irony of the whole Yahoo! management shakeup. While old management badly needed to go, the cost of bringing in new management was very, very expensive. The hiring of Henrique de Castro as COO from Google has been estimated to cost the firm around $56 million from 2012-2015. Can Castro be the turnaround guy? Or is that money better set on expanding through different outlets. He also reportedly does not have a good relationship with Michael Barrett, Yahoo!'s revenue financial officer.

Second, the decision by SoftBank to acquire a 70% stake in Sprint will also weaken revenue potential. It had been speculated that SoftBank would purchase a 35% position in Yahoo! Japan, but its mobile acquisition now appears to have stemmed that rumor.

As for Facebook, revenue growth is decelerating quicker than a firm with a PE multiple of 31.5x forward earnings should see. While cash holdings may be excellent for takeover activity at 11.6x, thus far the company has spent recklessly. The purchase of Instragram, for example, cost Facebook an entire year's worth of profit. And last I heard, users have become bored with the layout.

I also believe that worse-than-expected results are evidence that the company is trying to obscure the worst. It's no secret that the bears think the site is a fad. What is a secret, however, is whether it is already fading out. While earnings calls have to mention the results for what they are, speakers can often get around the negatives by, of course, framing the discussion.

In Facebook's earnings call, the executive make a significant amount of comments about "what's new" and "the future," without saying much about whether or not active users have increased or decreased time on site. If active users become bored with the site, the results won't necessarily manifest themselves if new users come in and overwhelm the data. Of course, the exodus of once active users will entice new ones (who probably came on with the intention of "friending" the active ones), which will lead to the downfall of Facebook. That's why it's this metric that shareholders should ask for at the next earnings call.

Interested in Additional Analysis?

After the world's most-hyped IPO turned out to be a dud, most investors probably don't want to think about shares of Facebook. But The Motley Fool has outlined some things every investor needs to know about the company in a new premium research analysis. Access the report now by clicking here.

• Email
• Print
• Feedback