Google's China Conflict Escalates, Making Shares a Screaming Buy

Google (GOOG) escalated its conflict with the Chinese government Monday, ending weeks of suspense by stopping its self-censorship of Chinese-language search results in the Middle Kingdom. The Communist government isn't really known for backing down, so Google's future in the world's most populous country looks as precarious as ever. That's bad news in the long run for Google shareholders, but meaningless right now. Based on fundamentals and valuation, Google is a screaming buy.

There's little question that, strategically, Google quitting China could come back to haunt the world's leading Internet search company. China, after all, is the world's biggest Internet market and its economy is expanding at a torrid pace. But that's a far-off concern. In the short and intermediate term, Google's business is brisk and its shares look compellingly cheap.

That's because although the potential shut down of Google's China business would be a strategic loss, "it carries no significant impact on revenues," wrote Jefferies & Co. analyst Youssef Squali, who rates shares as a buy. Sure, the China business could be huge one day, but for now it generates just 1% to 2% of Google's net revenue, the analyst estimates. "Exiting China would not be too damaging for Google since the company is the market-share leader in most nondomestic markets where search usage and monetization opportunities still abound," Squali wrote.

Shares Reach Bargain Prices

Meanwhile, the ongoing China tension has been punishing Google's stock all year, making it look like a bargain now. Google shares were left essentially unchanged by Monday's news, suggesting the worst has already been baked into the price. Let's certainly hope that's the case. The company's stock has fallen 10% so far in 2010. How bad is that? The Nasdaq Composite (COMPX) is up nearly 6% over the same span.

That underperformance has tamped down the relative valuation to almost irresistible levels. One of the most common ways to measure relative value is with the price-earnings ratio, which divides the current stock price by earnings per share. Google's forward price-earnings ratio, in which the current share price is divided by analysts' projected earnings per share, offers a 35% discount to its own five-year average, according to Thomson Reuters. The stock is even cheaper on a trailing-earnings basis, in which the current share price is divided by the earnings per share delivered over the last year.

But perhaps most intriguing is Google's price/earnings-to-growth (PEG) ratio, which measures how fast a stock is rising relative to its growth prospects. (The calculation divides a stock's price-earnings ratio with its projected annual earnings-per-share growth.) A PEG less than 1.0 suggests a stock is cheap, and that's where Google stands today, according to Thomson Reuters. That PEG offers nearly a 15% discount to its five-year average and -- wait for it -- a 50% discount to the S&P 500 (INX).

Analysts' median price target stands at $693, according to Thomson Reuters, giving Google an implied return of nearly 25% in the next 12 months or so. Now that the company's China Syndrome seems to have entered its final act, that upside looks to be eminently achievable.