A study of online advertising was recently released by the Interactive Advertising Bureau and PricewaterhouseCoopers. What it revealed is that internet advertising is growing despite the economic downturn. Total online advertising revenue for the third quarter neared $5.9 billion. That’s an11% improvement from last year’s third quarter and a slight 2% gain from the previous quarter. The study also concluded that year-to-date web advertising has brought in $17.3 billion, which is an improvement from $15.2 billion through three quarters in 2007. This study should not be considered the final authority on interactive advertising, but it does demonstrate an apparent resilience in the face of economic hardship.
The study is welcome news to Google (GOOG) which has seen its stock fall by 60% so far this year. Apart from the generally negative momentum of the stock market, Google’s stock has suffered from the expectation that its search-engine-based advertising would suffer as companies strip their marketing budgets. Advertising has been curtailed significantly as many retailers are struggling and the automakers are just trying to stay in business. However, the brunt of the pull-back has been felt in more traditional media like television and print. Growth in what is termed interactive advertising has not suffered nearly as badly. One potential reason is that with the interactive advertising results are more easily quantifiable because mouse clicks are tracked. By tracking where eye-balls are looking, advertisers can know what is working and what is not, which is of course very valuable.
When it comes to bringing traffic to your interactive ad, there is no better company to work with than Google. Internet searching continues to grow, as we mentioned in our October 1st piece (Just Google It). A Pew internet usage study found that now half of all internet users surveyed use a search engine at least one a day. Only one-third did in 2002. What has happened in the meantime? Oh that’s right, Google happened. Of course, I am only kidding, but Google’s dominance in search traffic is astounding. Month after month Google generates around 70% of web queries. Google has hit the “sweet spot” of having incredible proprietary search technology, a single and clean layout, and loads of open source programs and widgets for an ever growing internet audience. The company is suffocating its weaker search competition such as Yahoo! (YHOO) and Microsoft (MSFT). These factors all enable Google to attract internet users from beginner to expert to its site as well as offshoots. However, as its stock price swoons, Google has begun to monetize it’s formerly ad-free Google Finance site.
Our readers will remember that we believed that GOOG was Undervalued at around $400 and now that the price is down more than 30% to $275, we have GOOG rated Greatly Undervalued. The markets are fearful but by our indications Google is doing the right things as both revenues and earnings continue to grow. Sales growth for 2008 is estimated to be 36% and earnings for the year are expected to be up 25%. That assumes that 4th quarter results are in line, and they probably won’t stray too much from these estimates.
Google has been strengthening its fundamentals but its stock continues to slide, so by any historical valuation method, Google is very cheap. Price-to-sales has historically ranged between 7.17x and 14.3x, but the current price-to-sales is a meager 4.66x. Similarly, the historically normal price-to-cash flow range is 24.2x to 48.99x, but the current price-to-sales is just 15.12x. For Google to return to just the low end of these fundamental valuation ranges, we would expect to see the price in the upper $400’s. Some would say that we are overly optimistic, but Google has continued to thrive during a tough environment and we expect them to remain the top search engine and internet advertising business into the foreseeable future. Consider the words of Piper Jaffray’s esteemed technology analyst Gene Munster as he endorses Google (he has a buy rating and a $600 price target on GOOG):
“Google continues to be far and away the best company in the Internet space and operates in an advertising vertical (direct response) that historically fares well in an economic downturn. We believe this combination makes Google the top Internet stock to own in the current economic tumult.”