Is Google or Facebook a Better Bet in Digital Advertising

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

Digital advertising is experiencing substantial growth as companies continue to make the shift from traditional forms of advertising. Investing in tech companies that profit from digital advertising may be a smarter move than those that create products such as smartphones and computers.

Apple and Samsung’s difficulty meeting sales forecasts could mean that we have reached market saturation for the once explosive smartphone market. Much like the PC market over a decade ago, enough people own high-quality smartphones that there is no longer the same growth potential. Digital advertising is immune to this because demand is driven by businesses looking to grow rather than consumer habits. Investing in digital advertising really boils down to two companies: Google (NASDAQ: GOOG) or Facebook (NASDAQ: FB).

Current Valuation

Facebook is a fifth of Google’s market cap and is expected to have much higher growth rates in the near future. This growth potential is baked into Facebook’s price as it has significantly higher valuation metrics than Google. I look at a company’s Price to Earnings Growth (PEG) ratio as well as its Price/Earnings (P/E) ratio when analyzing valuation. This provides a clearer picture on how much investors value a company’s expected growth as well as how much they value that company’s earnings. I use numbers from the Nasdaq website based off of estimates provided by Zacks Investment Research.

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As you can see Facebook has significantly higher ratios for both its forward P/E, what its earnings multiple will be based on the next year's earnings, and its PEG. This means that investors not only price Facebook’s earnings at a premium; they also price Facebook’s expected earnings growth at a higher ratio. Both have similar cash levels relative to market cap. Facebook has $9.5 billion compared to a market cap of $61 billion, while Google has $50 billion compared to a market cap of $300 billion.

I believe Google is the smarter investment, especially at these valuation levels. It is impossible to definitively say which business model will be more successful, but it is easy to show that Google faces less risks and is in a better position to dominate digital advertising.

Risks and Advantages

The biggest risk Facebook faces comes from Google+.

Google+ has signed on hundreds of millions of users since release, and if user engagement starts improving it could signal disaster for Facebook. This is possible because for anybody plugged into the Google Matrix,  the next step to using Google’s plethora of free products is to use Google+.

Beyond that, the evolution of social networks has always shifted to the social network that is more focused on connecting people. The move from Xanga to Myspace occurred because Myspace focused more on communicating with friends rather than personal ramblings. The subsequent move from Myspace to Facebook occurred because it was focused on keeping in touch and talking to people, rather than creating a personal page about yourself. It is not inconceivable to see a similar change from Facebook to Google+. The key point, however, is Google+ doesn't have to replace Facebook to continue being successful, but if it does Facebook will become much smaller than it is today.

Both companies face privacy risks due to the nature of their business. For them to provide the effective advertising platform that they do; they need to have data on their users. Facebook, however, is more at risk to these privacy issues. Facebook users put their personal information online when using Facebook, and this makes it imperative that Facebook correctly monitors privacy issues. Beyond government scrutiny, Facebook needs to make users feel safe enough to put their lives online. Meanwhile people who use Google products such as search, maps, or YouTube are much less likely to feel threatened about Google keeping tabs on things they looked up in the past.

Google’s first place position in digital advertising comes from them not just making search advertising money, but also display advertising money whenever somebody views a YouTube clip or visits a Google site. In fact Google has recently taken the top spot in display advertising, Facebook’s bread and butter, away from Facebook, and is expected to hold this lead. While Facebook is dependent on users continuously spending more time on Facebook and viewing the display ads; Google can make money in more ways than one. 

Making the Bet

The extra risks Facebook faces along with Google’s broader online presence is why Google is the better company for making a bet on digital advertising. The fact that Facebook is valued at significantly higher ratios further supports investing in Google. Quite simply Google has a stronger position in online advertising, faces fewer threats to that position, and is cheaper to invest in.

Xuebing Wang has no position in any stocks mentioned. The Motley Fool recommends Facebook and Google. The Motley Fool owns shares of Facebook and 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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