Stock Smackdown: GOOG vs. YHOO

October 21, 2009

Competition is the name of the game on Wall Street. Companies are constantly scrambling to claim a piece of the spotlight and attract the bulk of the buying pressure away from industry peers.

Among investors, perhaps the most widely talked about battle is the one between the Internet search giants, Google (GOOG) and Yahoo (YHOO).

In terms of market share, Google claims more than 60% while Yahoo’s stake hovers around 20%. But a company’s size doesn’t necessarily translate to more profits for investors, which is why I only pass judgment based on the numbers. Now that both search behemoths have reported their latest quarterly earnings, investors can get a clear reading on how these companies are performing at present and how they will continue to perform in the months to come.

Three Golden Rules for Investors to Follow

While there are a plethora of indicators we could use to gauge the health of a stock, I have three in mind that are critical to sizing up a company and determining whether it is a good investment right now:

Earnings Growth: This is the heart of all good financial analysis, and I rely on it as well. As long as any company is able to grow its earnings consistently, its stock will do well.
Sales Growth: I like a company that can grow its sales over time. Why? Because it’s one number that is hard to fake. Sales growth is a solid indicator.
Positive Earnings Revisions: I like to see stocks that have had their earnings estimates increased by Wall Street analysts. This usually tips us off to a stock that’s about to “beat earnings.”

So how do Google and Yahoo stack up? Let’s take a look at the numbers.

Earnings Growth

Google: In the latest quarter, GOOG earned $1.64 billion, or $5.13 a share—a 27% increase from the same time last year. Excluding one-time charges, the company’s profit came in at $5.89 a share, beating the consensus by 8.7%.

Yahoo: YHOO reported earnings of $186 million, or 13 cents a share. That’s more than triple the $54 million, or 4 cents a share, the company earned during the same year-ago period. Analysts were expecting earnings of 7 cents a share, so YHOO beat estimates by 85.7%.

Sales Growth

Google: Revenue for the period climbed 7% to $5.94 billion. Not only is this also better than estimates, but it is the company’s fastest growth rate so far this year.

Yahoo: While YHOO’s earnings more than tripled, revenue slipped by at least 12% for the third quarter in a row.

Positive Earnings Revisions

Google: Thanks to GOOG’s solid quarterly results, 29 analysts have revised their earnings forecasts higher in the last seven days alone. This indicates to me that Wall Street expects real top line growth from Google in the quarters to come.

Yahoo: The company’s threefold increase in profits compared with last year has more to do with aggressive cost-cutting measures (including laying off workers) than it does real growth. While many analysts are betting that YHOO’s balance sheet will continue to improve, current EPS forecasts have stayed put.

And the Winner Is…

…Google, and by a long shot, too. The 11-year-old Internet search giant left the recession eating dust in the third quarter.

The company’s growth is clearly accelerating, which bodes well for the state of online commerce in general. The health of Google’s business is a pretty reliable gauge of online consumer spending because its search engine is the control center of the Internet’s biggest advertising network. The company processes nearly two-thirds of web-based search requests in the U.S., and because it’s such a massive hub, GOOG appeals to a lot of advertisers.

The online advertising market has struggled over the last 14 months, but Google’s latest quarterly results indicate that the tide has shifted—the number of paid clicks on the company’s sites rose 14% from the same year-ago period, and the average cost advertisers paid to Google increased about 5% from the second quarter of 2009.

Yahoo, on the other hand, which specializes more in online billboard advertising, is having a harder time regaining its footing on the ad front. The company did manage to increase its display ad sales 2%, but the growth is attributed more to an overall improvement in the economy. And while YHOO’s net income tripled, a chunk of those profits ($98 million) came from the one-time sale of its stake in China’s Alibab.com.

So the bottom line is this: The latest earnings reports from these two companies indicate that while Yahoo is still trying to turn a corner, Google already has.

I rate GOOG a “B,” or buy.