Despite All The Issues - Google Shares At All Time High

Nauman is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Eight years after becoming a public company, Google's (NASDAQ: GOOG) challenges are far from over. The company faces a daunting task of rejuvenating its core business of advertising, which has faced sluggish growth in the recent few years. Google has realized that advertisers are reluctant to pay as much for the small mobile screens as they pay for the large desktop screens. Consequently, the shift from the desktop to mobile has led to a continuous fall in the average revenue per click over the last few quarters.

Moreover, this shortfall has been everything but linear. Revenue per click fell almost 14% in the third-quarter of 2012, whereas in the fourth-quarter of 2012, revenue per click reduced by 6%. I believe this factor will continue to affect Google going forward -- unless it keeps increasing its advertiser base at a faster rate.

Still, the company was able to post consolidated revenues of $14.40 billion in the fourth quarter of 2012, 36% higher than the prior-year quarter. Net income also increased 7% to 2.90 billion from $2.70 billion.

On the other hand, Google's shares have not only outperformed the NASDAQ technology index, but are also outperforming the NASDAQ composite index for the last 12 months. Overall, Google has given a return of more than 25% in the last 2 years, 31% in the last 1 year, 22% in the last 6 months, and 18% over the last three months to its shareholders.

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But the real question is whether this will continue. Will Google's stock continue to give similar returns in the future? A number of factors will decide the answer to this question.

In order to keep up with the ever-changing technology landscape, Google is trying to reduce its exposure from just having one source of revenue. Google recently acquired Motorola Mobility to further strengthen its Android platform. This step is believed to be Google's entry into hardware, in direct competition with companies like Apple and Samsung.

The company also introduced Google+, in order to compete with Facebook in the social media space, but so far Google+ hasn't worked out the way Google wanted. Moreover, Microsoft (NASDAQ: MSFT) Windows 8 has entered the smart-phone software market, where Apple iOS and Google Android are the current market leaders. With a recent collaboration with Nokia, Microsoft's Windows 8 will be able to get improved hardware support and is expected to give a tough time to Google's Android. It's hard to know how current challenges affect each of Google's divisions, since the company doesn't reveal financials in each of its segments separately.

Despite the challenges, Google's fundamentals are really strong. Google is still a leader in the search engine business, is a market leader in the internet browser space, its Youtube platform is becoming ever popular, its operating system Chrome is gaining market share, and the launches of Google TV and Google Books. I think with the continuous plans to diversify, the company is set to continue its growth path in the near future.

Google Current Valuation

Google trades at 20 times trailing earnings. Analyst expectations call for $45.40 in EPS for the current fiscal year, and the current stock price is 18 times that forward figure, compare to its peer average of 33 times earnings. Google has impressive cash flow generation, with an operating cash flow margin of over 30%. And when I look at the enterprise value implied by the current stock price, it is only 13 times trailing EBITDA. That's not as obviously low a multiple, but still well within value territory for such a large and growing company. 

I'm comfortable with a long-term revenue growth outlook of 15% to 20% on Google, along with steady improvement in cash flow generation. All told, I think Google can grow its cash flow at a 10%-15% rate for the long term. Discounting that back suggests a fair value of about $853.

Admittedly, that's not a compelling target relative to today's price, but stocks like Google don't often give investors a chance to buy at a substantial discount to a fair value. While I'm indifferent about buying Google at these levels -- as the shares trade near their all-time high, I'd certainly consider a purchase if a broader market sell-off or periodic tech-is-overbought panic sends the shares down. I would wait for the shares to drop to the mid-to-high $675-$700 level, where they present an attractive risk/reward balance. Sub-$700 is where I'd start a long-term position.

MaaniValueGuru has no position in any stocks mentioned. The Motley Fool recommends Google. The Motley Fool owns shares of Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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