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Straight From the Founders: Google Doesn't Care About Profits

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

Investors in Google (NASDAQ: GOOG) have reaped enormous capital gains since its 2004 IPO.

  • Google's search engine is second-to-none, commanding an 86% share of all search engine traffic worldwide
  • Its cloud applications (e.g., Gmail) are ubiquitous
  • Its "Don't be evil" slogan has earned the company a cult-like following

However, despite the tremendous potential that still lies ahead, investors should carefully consider whether Google is being run with shareholders' interests in mind.

Any honest evaluation of Google quickly raises red flags in corporate governance. Google's share classes are structured in a manner that gives complete control to co-founders Larry Page and Sergey Brin. Page, Brin, and Eric Schmidt control a majority of the voting power while owning a minority of the equity. Contrast this with Yahoo! (NASDAQ: YHOO), which has only one class of shares and is owned primarily by institutional investors. Yahoo! must create value for shareholders or else management will get kicked out (as has happened on more than one occasion).

Google is more like Facebook (NASDAQ: FB), which is controlled by Mark Zuckerberg. Zuckerberg is free to do just about anything he wants at Facebook without the approval of minority shareholders. This is why both Facebook and Google receive low marks from corporate governance watchdog Institutional Shareholder Services.

To understand the full implications of the founders' control over Google, we must first understand their vision for the company. As with Facebook, Google went public in 2004 because it had breached the shareholder limit for a private company. Google did not want to go public or need to raise capital, it was done purely out of necessity to comply with the law. The company made clear early on that it was not run for the benefit of shareholders. It created a dual share class (and has since added a third class), has never paid a dividend, has a poorly-communicated corporate strategy, has wasted billions on non-core projects and acquisitions, and overpays its employees. Google's 2012 letter to shareholders, written by Larry Page, sheds some light on the company's direction:

We have a structure that prevents outside parties from taking over or unduly influencing management decisions...we want to ensure that our corporate structure can sustain our desire to improve the world.

This excerpt should stop every potential Google investor in their tracks.  Larry Page openly admitted that the company's primary goal is not to increase shareholder value, but to improve the world. This is a noble cause, and the world is better off because Google is more concerned about creating value for customers than maximizing profits. However, investors need to consider whether they want to jump on board with a management team that does not take their best interests to heart.

The impact of the company's strategic direction is most evident in its capital allocation. The vast majority of Google's profits are derived from search advertising, and the company hasn't shown it can create anything else that drives profits. Search is practically on autopilot, so where is all the money going?

Science projects! Google has had unsuccessful forays into renewable energy, home entertainment systems, and similarly bizarre projects that do not have much relevance to an advertiser-supported media company. In addition, all those cool applications like Google Maps don't make any money directly; they're just bells and whistles that provide customers with really useful (and free!) applications. Google makes all of its money from search, but invests most of its money in developing awesome products that improve the world...and don't make any money. This is not a formula for continued shareholder enrichment.

Many years ago my driver's ed instructor told me to "look where you want to go because you will naturally steer the car where you are looking." In my experience, the same is true with corporate direction. Google's focus is on creating products that make the world a better place, so those are the kinds of products they will make. Profit may result from some of these efforts, but profit will always be a secondary consequence, as if occurring by accident. I don't want to get on board with a management team that is looking one way while I look the other, and neither should you.

titans8904 has no positions in the stocks mentioned above. The Motley Fool owns shares of Facebook and Google and has the following options: long JAN 2014 $20.00 calls on Facebook. Motley Fool newsletter services recommend 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.If you have questions about this post or the Fool’s blog network, click here for information.

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