Everybody Loves Google — But for How Long?

Shares of search giant Google (GOOG) gapped lower in mid-April, after the company’s first-quarter earnings report hit the Street with a proverbial thud. Google revealed a profit of $8.08 per share, falling short of analysts’ expectations by two pennies per share amid rising expenses. The news inspired a flurry of price-target cuts from analysts the next day, and at least one downgrade — to "hold" from "buy," courtesy of Citigroup.

In the weeks since this unimpressive earnings event, GOOG has continued to struggle on the charts. A late-April rally attempt was halted in the $545 neighborhood, coinciding with the site of that aforementioned bearish gap. In fact, GOOG ended April below its 10-month and 20-month moving averages, marking the first monthly breach of this trendline duo since August 2010. Year-to-date, the tech titan is sitting on a loss of about 10%, significantly underperforming the broader equities market.

In fairness, the stock seems to have found a floor in the $520 region. Then again, GOOG bounced along support at $520 during the first four months of 2010, before breaking lower and ultimately bottoming at $433.63 last July.

Given the stock’s bleak price action, it’s interesting to note that GOOG’s analyst ratings are still tilted significantly toward the euphoric end of the sentiment spectrum — even in the wake of that post-earnings onslaught of price-target cuts. Currently, no fewer than 30 brokerage firms maintain a "strong buy" rating on the shares, according to Zacks. The rest of GOOG’s ratings are rounded out by four garden-variety "buys" and just three "holds," with not a single "sell" recommendation to be found.

Along the same lines, GOOG’s average 12-month price target stands at $703.83, according to Thomson Reuters. This consensus forecast implies expected upside of about 31.7% to Thursday’s close. For perspective, GOOG’s 52-week gain stands at a much more modest 7%, and the shares haven’t traded north of $700 since December 2007. In other words, analysts seem to have remarkably high hopes for GOOG, despite the disappointing earnings report and ensuing price plunge.

And this boundless optimism isn’t limited to the brokerage community, either. Short interest accounts for a nearly negligible 1.4% of GOOG’s float, suggesting that very few traders are betting on additional downside. Likewise, the stock’s Schaeffer’s put/call open interest ratio (SOIR) is docked at 0.71, with calls comfortably outnumbering puts among options slated to expire within three months. This ratio ranks lower than 69% of other such readings taken during the past year, indicating that near-term options players have been more call-heavy just 31% of the time.

Another indication of investor complacency can be gleaned from the current low level of implied volatility for Google options. Our Schaeffer’s Volatility Index (SVI) for Google now stands at 18 (indicating a weighted average implied volatility of 18% for the stock’s front-month options). Plus, Google’s SVI reached a nadir of 16 on April 29, which is tied for the lowest SVI level since we began tracking this data for Google in January 2007.

Ultra-low levels of option implied volatility have been quite problematic for Google shares in the past. Less than four months after its SVI bottomed at 17 on March 9, 2010, with GOOG trading at $560, the shares had plummeted by 22% to a closing low of $436. And GOOG was trading at $616 on Feb. 10, 2011, when the SVI last reached a trough at 16 — just ahead of a 14% share decline to a closing low of $525 late last month.

From a contrarian perspective, there are more than a few red flags surrounding GOOG at the moment. The shares are suffering a technical breakdown, and the latest quarterly results point to fundamental concerns, as well — but bullish sentiment still prevails across Wall Street. At a certain point, it’s going to become more difficult for these optimistic holdouts to argue that GOOG is "a bargain" at current prices. If upbeat analysts begin to abandon ship, it could trigger a fresh wave of selling pressure for the search giant.

Elizabeth Harrow

Schaeffer’s Investment ResearchResearch