G Is for Google

The days are numbered for the little girl on the "Learn Your ABCs" flash cards.

As Google (Nasdaq: GOOG) continues to steal search-engine market share from competitors Yahoo! (Nasdaq: YHOO) and Microsoft (Nasdaq: MSFT), it continues to strengthen its case to become the new representative for the letter G. Those "G is for girl" cards may be headed to the shredder, now that the search king has notched another quarter of massive growth.

For its fiscal first quarter, revenues rose 79% to $2.25 billion. International growth was particularly strong, now representing 42% of total revenues, compared with 39% in Q1 2005. The international uptick most likely helped bring high double-digit growth back to earnings, as the tax rate returned to a more reasonable 27%. The 41.8% tax rate in the previous quarter was a result of a larger-than-expected percentage of revenues from domestic business and was partially responsible for earnings not meeting analyst expectations.

One of the most pleasing things reported was that dilution from equity grants is expected to be approximately 1% to 1.5% per year. Dilution is always at the top of my checklist, especially with companies growing as quickly as Google. The rate of dilution for 2006 will be a bit higher, however, because of the additional 5.3 million shares issued in an offering completed earlier this month. Cash and cash equivalents are $8.4 billion, but they don't include the $2.1 billion raised in the offering, or the $1 billion investment in Time Warner's (NYSE: TWX) AOL that Google completed this month.

The Fool embraces free cash flow, and that's one of the biggest reasons, among others, that my colleagues have concluded -- many, many times -- that Google is overvalued. But problems in these types of valuations can occur when a high-growth company needs to makes significant investments in capital expenditure to fuel its growth. Without adjusting for growth capex, many companies can be mistakenly classified as having a high valuation for many years, even though they are continually increasing shareholder value at a rapid pace. This adjustment certainly needs to be made in Google's case, as it continues to invest in its IT infrastructure, global sales force, and the purchase of land and buildings. (Just be aware, of course, that spending for growth doesn't guarantee that growth.)

One thing is certain: An investment in Google will take a considerable amount of faith in management. Without a clear picture of what may be monetized next, estimating future revenues may become rather difficult. I don't have enough faith to say that Google is undervalued, but at $400, I still think market-beating returns are certainly possible.

Microsoft is a Motley Fool Inside Value recommendation, and Time Warner is a Motley Fool Stock Advisor pick. Take the investing service that best fits your style for a free, 30-day trial run.

Fool contributor John Bluis does not own shares in any company mentioned in this article. The Motley Fool is investors writing for investors.