Grate Google Expectations

Wall Street cynics are having a field day with Google's (Nasdaq: GOOG  ) coming up short last week. The stock dipped 5% lower on Friday, on the heels of what is only the second time that Google has clocked in below analyst projections. But rather than take it out on Google, some are pointing fingers right at back at the public and its typically lofty expectations of the search engine star.

"Here's a company that gives no guidance, yet it gets dinged for missing," wonders MarketWatch's Herb Greenberg in his blog. "Missing what?"

It's a fair point on the surface. Google is a company that has never caved in to provide forward guidance. There are no puffy projections of top and bottom line goals. It's not a game that Google has cared to play, and there is no harm in applauding that. The moment that you begin managing a company for quarterly expectations, you fall into a nearsightedness trap.

This doesn't mean that Google is unaware of the targets that others have been setting for the paid-search bellwether. It may occasionally try to nudge the pros off their targets -- as it tried a few months ago in laying out a call for heavy near-term spending to grow quickly -- but Google's lips are typically sealed when it comes out for its conference-call encore.

"I have no idea where Google should or will trade," Greenberg eventually writes. "That's not what I do."

However, by ridiculing the market's knee-jerk reaction on Friday, it may very well be interpreted as a valuation call. It's not. Greenberg has made some brilliantly bearish calls -- as he did on Krispy Kreme (NYSE: KKD  ) a few years ago -- without having to break out the tape measure.

My beef is only with folks who laugh at investors who put too much weight in a company's ability to meet, beat, and blow quarterly estimates. Yes, Google can be the next Marcel Marceau when it comes to vocalizing its outlook, but it has to thank the pros.

Google would not have gone from $85 to well over $500 over the past three years if it had not obliterated profit targets in 10 of its first dozen quarters as a public company.

Projections flicker on the big screen
Greenberg isn't the only one who can stand on the sidelines, amused at investors who chase companies that chase phantom expectations. Several of my fellow Fools -- folks whom I respect dearly -- hate to compare a company's ultimate performance to where the pros are perched.

I disagree. I value Wall Street targets as a useful research tool, especially if I have reasons to believe that a company will come in ahead of published marks. The market is a scale that usually weighs stocks based on future expectations. The best investors aren't the ones who follow the pro calls blindly. No, the winners are the ones who nail the stocks that will trounce the pros repeatedly.

Intuitive Surgical (Nasdaq: ISRG  ) is a pretty amazing company. Its robotic surgical arms are popping up in operating rooms everywhere. The stock has also been given the robotic thumbs-up, having risen a scorching 350% since being singled out in the Rule Breakers newsletter service two years ago. What's the secret? Well, last week the company whipped Wall Street's forecasts, something it has now done for 19 consecutive quarters.

Want another perpetual thumper? Try Apple (Nasdaq: AAPL  ) on for size. The company has come in ahead of the pros for 17 straight quarters. It will try to stretch that hitting streak to 18 when it reports its fiscal third-quarter results come Wednesday afternoon.

Let's take you back to April 16, 2003, the day that Apple beat the market for the first time in its uninterrupted run. Shares closed at a split-adjusted price of $6.62 that day. If you bought in then, you'd be staring at a better than 20-bagger stock.

Fundamentals reign supreme
Are there flaws in my argument? You bet. There are several instances in which companies "beat the Street" and still get roughed up by bearish thugs. eBay (Nasdaq: EBAY  ) fell last week, despite clocking in ahead of expectations. A disappointing near-term outlook and a dip in auction listings curbed investor enthusiasm.

It's all about the fundamentals. In that sense, the argument can be made that companies such as Apple or Google -- free of any Wall Street crystal balls -- would have still been market-beaters. Healthy earnings growth lowers P/E multiples while it raises the P/E multiple premiums that growth investors are willing to pay.

Yes, that's all true, but it's easier to catch on to the companies that are cleaning up nicely by weighing them against analyst profit targets on a quarterly basis. So you'll have to excuse me if I keep an eye on that metric in the future.

What did Google miss? It missed third-party estimates. What did the cynics miss? The point.

eBay is a Motley Fool Stock Advisor newsletter pick. Intuitive Surgical is aRule Breakers recommendation. Make the right call, and let it start with a 30-day trial subscription to either service.

Longtime Fool contributor Rick Munarriz is a huge fan of Google, and it would be his homepage if it weren't for Fool.com taking up that piece of real estate. He does not own shares in any of the stocks in this story. Rick is also part of theRule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. The Fool has a disclosure policy.


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