Why This Tech Giant Is a Buy Right Now
Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Google (NASDAQ: GOOG) is a technology company that has built its business on finding ways to breach the gaps between people and information. Google is primarily involved in advertising and operating systems, with most of its revenue coming from its popular ad service, AdWords. We place a very strong buy rating on Google that mainly reflects its leading position in the dot-com arena. This is evident from a high price multiplier that reflects investors’ confidence in the earning capability of the firm.
While we do not expect such a high earnings multiplier to prevail over the long term, we do foresee a significant upside to the stock’s current price level, owing to sizable cash flows and managerial efficiency. This rating takes into account potential benefits from Google’s acquisition of Motorola Mobility Holdings, Inc., which was a strategic move to strengthen the company’s patent portfolio. Despite a slight decline in market share, it is still the undisputed market leader in search engines today. We like Google because we believe that its continuous innovation, additions to and extensions of its product mix, and emphasis on satisfying consumers will keep it ahead of all internet information providers in the future, resulting in healthy profit margins.
Key Thesis Points
1. Google is the market leader in search engines, with competitor Yahoo! (NASDAQ: YHOO) trailing in second place with a very low share of the total market and a relatively weak financial position. Google has a net profit margin of 27% as compared to 11.2% for Yahoo. With a quarterly revenue growth (24.10%) and operating margin (32.11%) well above the industry average (18.30% and 5.28%, respectively), we see no reason to doubt Google’s profitability going forward. Management efficiency, measured via income per employee and revenue per employee, far outstrips what the current standing of the industry. This just serves to drive home the fact that the company is not only financially sound, but its numbers have sound management and an efficient workforce to back them up. Given its recent strategic initiatives, we expect the company to strengthen its market share, augmenting its bottom line.
2. Google has a stronger liquidity position than that which is commonly expected of its industry. This shows that the company operates with a comfortable cushion with respect to its current assets/current liabilities. The increase in current assets has come mainly from a decrease in accounts receivable, thereby improving A/R collection and increasing cash and cash equivalents. On the other hand, Google operates with a debt to equity ratio which is slightly lower than the industry’s requirement, signaling that if the need arises, the company would be able to safely take on more debt. This financial flexibility places the company far ahead of Yahoo. Google’s equity has increased due to an increase in retained earnings, which has been possible mainly because revenues in FY11 increased from FY10. If it takes on more debt in the near future, the company is financially viable to service it. This viability is further strengthened by its healthy cash flows from operating activities. Sales growth is currently behind the industry growth rate, but catching up.
3. Research and development expenses have increased for Google, demonstrating that the company does not rest easy, but, in fact, keeps looking for ways to come up with new products for its markets. Increases in these expenses are not only for the expansion of the company’s product portfolio, but they also reflects its orientation towards industry dynamics as a whole. To remain the market leader and produce what the consumer wants, Google needs to be at the top of its game on every front, all the time. The company clearly realizes how important innovation and creativity are within its industry, since highly technological industries are characterized by change, anticipating it as well as adopting it. Response times need to be fast, or else one ends up in a situation like that of Motorola.
Google is well aware of the need to remain competitive if it wants to be able to sustain its number one position in the industry. It understands the pulse of the market and its competitors, which is why it came up with offerings like Android, Google TV, Youtube, Google Maps, and Google Wallet. Whenever an opportunity to acquire a product Google can integrate with its existing products opens up, it goes ahead and grabs it. This is one of the strongest qualities the company possesses, and it leverages it well. Upcoming plans are to acquire Meebo and to buy Quickoffice, which it will use in sync with Google Docs. With increasing revenues, total assets, and equity, improved liquidity, adequate gearing, and no crunch in cash flows, the company’s growth in phones, PCs, laptops, social networking and entertainment will be made all the more easy.
Brief Valuation
Google is a growth stock with a price/book value of 3.07x, a current PE ratio of 17.3, and a forward PE multiple of around 11.4. The enterprise value to EBITDA is at an impressive 10, demonstrating strong valuation prospects for the firm. The firm’s beta is 1.15, which explains the volatility profile of the stock as being slightly more volatile than the market. This is not unusual for a firm that is part of a highly technological environment, susceptible to rapid changes and uncertainty. Going forward, based on the strong fundamentals stemming from its dominant market position, sizable cash flows, and expected PE multiplier, we value Google at $750.
Google is a cheap stock with strong growth potential, but its rival Apple (NASDAQ: AAPL) is even cheaper. Apple’s trailing PE ratio is 14.2, and its forward PE multiple is 10.8. For reference, Yahoo’s trailing PE ratio is 17.7, and its forward PE ratio is 13.9. We are bullish about both Apple and Google. These stocks are also the top two most popular stocks among hedge funds (see the 10 most popular stocks among hedge funds).
This article is written by Nawazish Mirza and edited by Meena Krishnamsetty. Meena has long positions in Google and Apple.
