Editor's Choice

A Good Value, But I've Got 2 Better Ideas

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

I'll state the obvious, Google (NASDAQ: GOOG) has been on quite a run recently. I remember not long ago when some investors including myself were questioning if the company's growth was slowing down. The shares were languishing, and investors seemed to be asking what's next? Over the last few months, this uncertainty seems to have melted away, and the company's current earnings paints a picture of healthy growth. However, because of the stock's run to new highs, I have to say, I see two other companies that look like better values.

This Race Is Over
I know that some still believe that the search market is evolving, and that Google could be replaced by another company. The short version of my answer is, this isn't going to happen. Google still controls more than 60% of desktop searches, and some have even estimated their mobile market share to be as high as 90%. When most users in the U.S. think of search, they think Google. 

One concern about Google's search business has been the change in their paid clicks versus the cost per click. I've written in the past, that Google is manipulating the cost per click to generate more paid clicks. Look at the movement of paid clicks and cost per click and I think you'll see the pattern:

<table> <tbody> <tr> <td> <p><strong>Quarter</strong></p> </td> <td> <p><strong>Paid Clicks</strong></p> </td> <td> <p><strong>Cost Per Click</strong></p> </td> </tr> <tr> <td> <p>Dec. 2011</p> </td> <td> <p>Up 33%</p> </td> <td> <p>Down 7%</p> </td> </tr> <tr> <td> <p>Mar. 2012</p> </td> <td> <p>Up 38%</p> </td> <td> <p>Down 12%</p> </td> </tr> <tr> <td> <p><span><span><a href="http://idc.api.edgar-online.com/efx_dll/edgarpro.dll?FetchFilingConvPDF1?SessionID=H1CiFtpjREJO8fS&ID=8723556">June 2012</a></span></span></p> </td> <td> <p>Up 42%</p> </td> <td> <p>Down 16%</p> </td> </tr> <tr> <td> <p><span><span><a href="/mhenage/2012/11/02/2-takeaways-googles-earnings/15675/">Sept. 2012</a></span></span></p> </td> <td> <p>Up 33%</p> </td> <td> <p>Down 15%</p> </td> </tr> <tr> <td> <p>Dec. 2012</p> </td> <td> <p>Up 24%</p> </td> <td> <p>Down 6%<span> </span></p> </td> </tr> </tbody> </table>

The pattern looks pretty obvious to me, when the company heavily discounts cost per click, their paid clicks increase. The fact that the company has backed away from this strategy in the current quarter, and still saw a 24% increase in paid clicks says Google is pretty comfortable with their position in the marketplace. I don't think it's any surprise that during Google's strongest paid click growth, Microsoft's Bing and Yahoo's combined market share has stagnated.

Growth & Income...Oh Wait...What Income?
If investors should worry about anything with Google, it would be the fact that huge revenue growth is producing relatively small EPS growth. In the current quarter, the company's revenue jumped 36%, but non-GAAP EPS increased just 12.11%. This theme seems set to continue, as analysts see revenue up 43.5% this year, but EPS is only expected to increase 14.34% on a year-over-year basis. This suggests the company might want to keep a closer eye on expense management. 

For all of Google's revenue and EPS growth, one thing that hasn't shown up yet is a dividend. Given that the company generated $3.65 billion in free cash flow in the current quarter, I have to wonder, what about a dividend? It would be one thing if Google were furiously repurchasing shares, but in the last year, diluted shares have actually increased by 1.82%. This leads me to my main point, without a dividend or significant share buyback, there seems to be better values available to investors. It might be time to take profits in Google and go a different direction.

I Know What You Are Thinking, But Look At The Numbers
The two companies that look like better values than Google at the current time are Apple (NASDAQ: AAPL) and Microsoft (NASDAQ: MSFT). I know some people are going to think I'm crazy, but this isn't about picking stocks based on what has already happened, but trying to figure out where we go from here. 

There are two simple reasons these companies look like better values. The first is, their growth and income relative to their current P/E ratios. Google pays no dividend and trades for about 17.15 times projected 2013 earnings. This gives the company a PEG ratio of 1.25. Apple on the other hand, has a PEG of just 0.55, with a forward P/E of 10.46 and expected earnings growth in the next few years of 18.98%. Apple's over 2% yield is just a nice kicker to this value. While Microsoft's PEG of 1.17 is only slightly lower than Google, keep in mind, Microsoft investors get a yield of 3.3%, whereas Google investors get nothing.

The second reason these two companies look like better values has to do with their cash generation and the cash on their balance sheets. Look at the value of their respective cash and investments as a percentage of their market cap:

<table> <tbody> <tr> <td> <p><strong>Name</strong></p> </td> <td> <p><strong>Cash & Investments</strong></p> </td> <td> <p><strong>Market Cap.</strong></p> </td> <td> <p><strong>Cash As Percentage Of Market Cap.</strong></p> </td> </tr> <tr> <td> <p>Google</p> </td> <td> <p>$48.1 billion</p> </td> <td> <p>$257.37 billion</p> </td> <td> <p>18.69%</p> </td> </tr> <tr> <td> <p>Apple</p> </td> <td> <p>$137.11 billion</p> </td> <td> <p>$439.38 billion</p> </td> <td> <p>31.21%</p> </td> </tr> <tr> <td> <p>Microsoft</p> </td> <td> <p>$79.02 billion</p> </td> <td> <p>$233.53 billion</p> </td> <td> <p>33.84%<span> </span></p> </td> </tr> </tbody> </table>

As you can see, Apple has 66.99% more relative cash to market cap value compared to Google, and Microsoft has 81.06% more. This might not mean much if Apple or Microsoft were burning through cash, but in their current quarters, both companies added billions to their respective balance sheets.

The bottom line is, investors buying Apple or Microsoft get a yield that Google does not offer, better relative values, and more cash per dollar of market cap. While Google has been on an impressive run, there is no guarantee this run will continue. Google may still do well, but I can't help but think Apple and Microsoft may do better in the near term.

MHenage owns shares of Apple. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple, Google, and Microsoft. 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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