Buy the Google Fortress at a Discount

By Alvin Gonzales - July 5, 2012 | Tickers: AAPL, FB, GOOG, MSFT, YHOO | 0 Comments

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Google (NASDAQ: GOOG) has a stranglehold on online search. Since 2007, even in the face of fierce competition, it has maintained a global market share near 80%. What is even more impressive is that Google actually increased its market share by 2% between 2007 and 2012.

source: netmarketshare.com

Google has even kept the Microsoft (NASDAQ: MSFT) empire at bay. Despite Microsoft's best efforts, Bing has only managed to capture about 4% of the online global search market. Furthermore, the growth of Bing has come at the expense of other search engines such as Yahoo (NASDAQ: YHOO), which previously had an 11% share in 2007. Yahoo now only has a 6% share. Basically, Google has a search fortress.

However, there are legitimate concerns about some possible cracks emerging at the Google fortress. In its most recent earnings call, Q1 of 2012, Google reported that its cost per click was down 12% from the previous year and down 6% from the previous quarter. This is on top of an 8% decrease in Q4 of 2011 from the previous year and previous quarter.

Cost per click is the average amount Google gets paid each time someone clicks on one of its ads. Of course the decline is not good, but it is not an over encompassing statistic. Also, there are many factors that affect the number. In Google’s 10-Q report, the company wrote,

“The decrease in the average cost-per-click paid by our advertisers was driven by various factors, such as the general strengthening of the U.S dollar compared to certain foreign currencies (primarily the Euro), the changes in platform mix due to traffic growth in mobile devices, where the average cost-per-click is typically lower compared to desktop computers and tablets, and the changes in geographical mix due to traffic growth in emerging markets, where the average cost-per-click is typically lower compared to more mature markets.”

It seems that there is at least some truth to the explanation. In the quarter, Google still grew its revenue, non-GAAP net income, and non-GAAP earnings per share by 24%, 26%, and 25% year over year, respectively. The GAAP numbers are even higher with growths of 61% and 59% in net income and earnings per share, respectively.

Looking at Google’s performance over the last ten years, the company has been very consistent.

Google has grown its revenue, net income, and earnings per share every year since 2003, where earnings per share decreased by four cents.

So what is the value of Google? Google currently has a tangible book value per share of $162.15. Using conservative discounted cash flow analysis, the company is worth about $460 per share. That calculation is conservative because it assumes zero growth and Google is a great growth company. Assuming an annual growth rate of 10% for the next ten years, Google is worth about $760 per share. Google grew its earnings by 26% in Q1 of 2012, and has been experiencing pretty consistent double digit growth over the past 10 years, so 10% is not an absurd number.

This growth can occur through a number of ways. First, the number of people that use the internet is only about a third of the world population. Thus, Google search has a huge untapped market. Second, Android is dominating the smartphone market. Android has 56.1% of the global market and Apple (NASDAQ: AAPL) iOS has 22.9%. If Google gets serious and decides to start licensing Android, the boost in revenue could be huge. Currently, Google licenses Android for free. Also the high percentage of Android smartphones provides protection against Apple’s vendetta to destroy Google and Android. Apple recently removed Google Maps from its iPhone 5.

Lastly, Google+ and YouTube can be a huge source of ad revenue. YouTube is the king of online video and Google+ is a social networking service released to battle Facebook (NASDAQ: FB). Facebook has been diverting search results away from Google because users are able to get information from their friends instead. Google+ currently has over 250 million users. This is still less than Facebook, which has over 800 million users, but the service has been gaining traction.

The bottom line is that there are plenty of growth opportunities for Google. Most importantly, Google has a dominant position in a key market segment, online search, that is growing and it can fall back into if some opportunities fail. Right now, at its recent price of $587 per share, Google is not priced for much growth and investors should take advantage.

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