There's No Place Like Home

By Chad Henage - July 25, 2012 | Tickers: AAPL, FB, GOOG, YHOO | 0 Comments

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If you're looking for the perfect tech stock to invest in, you should consider Google (NASDAQ: GOOG). For the last several quarters, each time Google has reported earnings, they have been more impressive than the last. When you look at their competition, each has their own strengths and weaknesses, but Google appears to only have strengths.

With many people setting Google.com as their homepage on their browser, the company becomes the default location for millions of web users. Google is the dominant search engine with over 60% of the market. If this wasn't apparent enough, think about when was the last time you heard someone say, Can you please Bing that for me or Will you Yahoo that for me? When users refer to your brand as the common name for online search, you know that you dominate your industry.

Consider that for the last few quarters Google's paid clicks have increased each time the company has reported earnings. While the company's cost per click has also declined each time, I personally believe this is intentional and a way to drive more customers into Google's arms. The company is also the model of efficiency when it comes to traffic acquisition costs (TAC), a primary measure of the value of a search engine. For the last several quarters including their recent report, TAC has averaged between 24% and 25% of revenues. To show the massive difference between Google and one of their main competitors, Yahoo (Nasdaq: YHOO), consider that the latter showed search revenue down 1.24%, while TAC increased 11.58%. Clearly Google is generating tremendously more paid clicks and is being more efficient controlling traffic acquisition costs.

While many people look at Google's paid clicks as the primary number to determine the company's success, by nearly every financial measure the company is doing very well. In the current quarter, revenue grew over 20% while EPS grew by nearly 16%. The company also generated a tremendous amount of cash flow from the business. Operating cash flow increased by 20.74% year-over-year, and the company benefited from about $3.5 billion worth of free cash flow in the current quarter alone. With cash and investments at over $43 billion, the company also has one of the largest war chests in the market today. Last but not least, Google decreased their total share count by about 1.5% on a year-over-year basis. With this type of across-the-board dominant performance, you might infer that the company's competition does not stand a chance.

In the technology field, it's never safe to assume that your competition can't match what you have to offer. While Google is the dominant leader in search, the company is not the leader in each of the categories that it competes in. For instance, Google+ while an interesting concept, it has nowhere near the number of users or interaction as Facebook (NASDAQ: FB). Some would argue that the reason for this is that Google+ was introduced far after Facebook became the dominant social networking site. While this could be true, it doesn't change the fact that Google+ clearly lacks the engagement of Facebook. Many active Facebook users spend as much as 7 to 8 hours a week on the site. I've actually seen comments on Google+ that say if this had come out first, Facebook might not exist. The problem is their following comment is usually something along the lines of, “but since Facebook does exist, why do I need Google+?” In addition, Facebook's advertising strategy is completely different from Google. Facebook aims to advertise as part of its users newsfeed, as opposed to separated ads from the information users are looking at. This becomes a challenge over time for companies such as Google, where display ads are more easily ignored as users become accustomed to where these ads appear and simply look elsewhere. A major battleground for Google in the future seems to be in mobile phones.

While the company's Android operating system enjoys a category leading market position, this system really makes almost no money for the company. In fact, I've seen it speculated that Microsoft actually makes more money off of Android than Google does. In addition, while Apple (NASDAQ: AAPL) is technically in second place when it comes to mobile operating systems, the company generates a huge amount of free cash flow from the sale of its devices. Since Google and Motorola are now one, the company says it's excited about the possibilities of producing combined hardware and software solutions that customers will enjoy. One thing that Google will realize very quickly is that hardware margins and software margins are completely different. For instance, Google's existing gross margin is nearly 64%, versus Motorola's most recent gross margin of less than 18%. In theory, this means the more hardware Google produces the lower the company's overall margin should be. By comparison, Apple sported a gross margin recently of over 47%. Given that the company sells hardware with software that it developed, this is a huge gross margin for the company. In addition, while Google's $3.5 billion in free cash flow sounds impressive, in the last quarter Apple generated over $12 billion. The point is, Google will not have as easy of a time dominating companies like Facebook and Apple as it did competing with Yahoo.

I've seen several articles where the author compared Apple and Google as investment options. I can certainly see the similarities, as at this point both companies can produce hardware and integrated software in the mobile market. However, Google's primary business is still Internet search, whereas Apple's primary business is hardware sales. What's interesting is both companies have a share price over $600. For the same $600, investors can choose Google at about 14 times 2012 earnings, and a future growth rate of over 17% and get a very good deal. Investors also could choose to spend this $600 on one share of Apple, which sells for 12.89 times 2012 earnings, and is expected to grow at 21.87%. As you can see, either choice looks attractive depending on what investors are looking for.

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