American Funds Takes a Big Shine to Google

When Google Inc. reports quarterly earnings today, it will probably have the rapt attention of a mutual fund firm that usually looks askance at such flashy stocks: Los Angeles-based American Funds.

The funds’ parent, Capital Group Cos., has become the third-largest institutional shareholder of Google, with nearly 8% of the stock as of March 31, according to Capital’s most recent filings with the Securities and Exchange Commission.

What’s more, the Internet search leader’s stock has become the No. 1 holding in Growth Fund of America, the biggest fund in the American Funds family and also the nation’s largest equity fund, with $105 billion in assets.

Google accounted for 2.1% of Growth Fund of America’s assets as of June 30, according to the American Funds website. The stock also was the top holding in the company’s $7.1-billion New Economy fund.

American Funds’ stake in Google may surprise some of its shareholders because the fund firm has long been known as a “value” investor, meaning it typically focuses on issues that look like relative bargains compared with their earnings per share.

Indeed, besides Google, Growth Fund of America’s top stock holdings include such classic value issues as tobacco titan Altria Group and telecom company Vodafone Group.

Google, by contrast, now is viewed as one of the technology sector’s preeminent growth stocks, the kind that sport lofty share prices compared with underlying earnings. With such high price-to-earnings ratios also comes higher risk of a plunge in the stock if the company stumbles.

An American Funds spokeswoman said the firm did not publicly discuss its holdings. But analysts who follow Google say the fund giant must believe that value is in the eyes of the beholder.

Google stock, which rose $2.10 to a record $312 on Wednesday, now sells for about 60 times analysts’ average 2005 earnings estimate of $5.17 a share, according to data firm Zacks Investment Research. By contrast, the average U.S. blue-chip stock’s price-to-earnings ratio is about 17.

Investors almost always are willing to pay up for the fastest-growing companies, however. And Google’s earnings growth rate is expected to average 31% a year over the next five years, based on analysts’ projections as tracked by Zacks.

Using that growth estimate, Google’s earnings could reach about $11.60 a share in 2008. At the current stock price, the price-to-earnings ratio is a more reasonable 27 based on profit of $11.60 a share.

Of course, in the dot-com stock crash of 2000-2002, investors learned the hard way about the potential peril in trusting ebullient long-term profit growth estimates.

Paul Herbert, who follows American Funds for investment research firm Morningstar Inc. in Chicago, said that although the firm has a long-term reputation for being value-conscious, it also is willing to make substantial bets -- and be patient -- when it believes an industry has particular promise.

In its stock holdings, Growth Fund of America is “big on the Internet overall now,” Herbert said. The fund’s major holdings include Net commerce company IAC/InteractiveCorp. and “content” firms including Time Warner and Liberty Media, among other Net bets, Herbert said.

But he noted that the fund, like all of American Funds’ portfolios, also stresses diversification to limit risk. Google was Growth Fund of America’s single largest holding as of June 30, but oil and gas stocks comprised the largest industry sector in the fund, at 9.3% of assets, according to the American Funds website.

Still, Google has been a strong contributor to the fund’s return this year. The stock is up nearly 62% year to date, a far larger gain than any of the fund’s other top-10 holdings.

Growth Fund of America’s class-A shares are up 6.1% this year, compared with a 2.9% return for the blue-chip Standard & Poor’s 500 index, including dividends.

Based on its SEC filings, it appears American Funds did not buy Google in the company’s initial offering last August. The fund firm’s purchases were made in fall and winter and as recently as March, when the stock was mostly trading between $175 and $190 a share, more than double the IPO price of $85.

With the stock now above $300, that’s too rich for Philip Remek, an analyst at brokerage Guzman & Co. in Coral Gables, Fla. He is advising clients to sell, though he acknowledges he’s in the minority on Wall Street.

“There is an aura that they can do no wrong,” Remek said of Google. That’s often a danger sign for a stock, he said.

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Here are the 10 biggest stock holdings in Growth Fund of America and how the stocks have performed this year.

*--* YTD Rank Stock change* 1. Google +61.8% 2. Target +15.5 3. Lowe’s +14.7 4. Microsoft -2.0 5. Altria Group +8.5 6. Time Warner -14.4 7. Vodafone -9.4 8. Schlumberger +17.2 9. Sanofi-Aventis +6.4 10. Texas Instruments +27.9

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*Not including dividend income.

Sources: American Funds, Bloomberg News