Why Google is Still a Value Stock Despite Approaching All-Time Highs
In recent trading sessions, shares of technology giant Google (NASDAQ: GOOG) have touched new all-time highs as the stock has staged a significant rally over the last 3 months. Despite the run-up in the price, this is a stock that should be on the radar of value investors who focus on extremely high quality companies trading at reasonable valuations.
In addition to its high quality and value metrics, Google is also setting up on a technical basis. The most recent rally in the shares has caused Google to break-out above a trading range that goes all the way back to the beginning of 2010. Frequently, a break-out from a long-term consolidation area is a bullish sign. In Google's case, the fundamentals are also confirming the attractive technical outlook.
While some value investors tend to shun technology stocks because of the difficult nature of projecting the future of the business, some companies should be given exceptions, particularly Google (NASDAQ: GOOG) and Apple (NASDAQ: AAPL), which meets most other value criteria. Unlike many technology companies, Google's core business is fairly straightforward and easy to understand.
Google is the gatekeeper to the internet with its dominant search business. According to the company's data, Google further grew its position as the top search provider in the United States in June, with a record 66.8 percent share of the market. This topped the prior month record of 66.7 percent. These numbers suggest that Google's primary business is becoming even more dominant over time.
One of Warren Buffett's investing axiom's is that "time is the friend of wonderful businesses and the enemy of mediocre ones." In Google's case, this has proven to be correct.
Google is even more dominant in the fast growing international search category, although its market share has been falling over time. As of April, Google commanded around 80 percent of search outside of the United States and the UK. While competitors such as Yandex (NASDAQ: YNDX) and Baidu (NASDAQ: BIDU) do well in certain regions, these companies are but niche players in relation to Google's dominant global position.
The importance of the company's search business is that it provides a near-impenetrable moat around its primary revenue driver -- online advertisement through AdWords and AdSense. The value of Google advertisements to merchants, as a result of the company's stranglehold on the search market, has been proven over and over again. There are few -- if any -- ways for merchants to deliver advertising with the same precision and relevancy that Google offers them.
Furthermore, Google offers its customers a rich array of metrics and data to help them drive efficiencies across their businesses. The company also has a host of other emerging businesses, most notably its leading presence in the rapidly growing mobile market through Android. Google has also made a successful foray into social networking with Google+ and owns the ever-popular YouTube web property.
While these are among the most visible "seedling" businesses under the Google umbrella, there are literally hundreds more. This is where the company's valuation comes into play. In sum, it is simply too cheap relative to the innovation potential of Google. In fact, it is likely too cheap absent any future innovation considerations.
If you look at the company's financial performance over the last five years it has been a model of consistent growth. Consider that in fiscal 2008, the company recorded revenues of $21.795 billion. This compares to its fiscal 2011 revenues of $37.905 billion. Net income went from roughly $4.227 billion to $9.737 billion during the same time period.
Wall Street analysts are projecting that the company will grow its top line by 16.20 percent next year and 15.19 percent over the next 5 years. While this is roughly 8 percent less than what the company has done over the previous 5 years, its is still very respectable for a company as large and high quality as Google.
These projections are also highly speculative. The fact is that there is very little innovation premium in Google stock and analysts' projections. Currently, the market is valuing Google based on what it is today -- and it could be argued that the company in its present state remains undervalued.
The stock trades at a trailing P/E of 20.56, a forward P/E of 14.03 and a PEG ratio of 1.08. Given that Google is one of the best businesses in the world, this low valuation implies very little optimism about the future of the company. There are only a handful of companies in the world that have the cash, talent, culture, and pedigree to create brand new multi-billion dollar markets out of thin air -- and then dominate those new markets. Google is one of them.
Any one of the seedling businesses that Google is currently cultivating could become the company's next multi-billion dollar revenue stream. In fact, investors should count on Google launching massively successful businesses in the future that are only now being conceived. The company has a culture of innovation and creativity that is nearly unparalleled. It also has many of the world's most talented engineers on its payroll and was sitting on around $43 billion in cash at the end of the second-quarter.
This is enough cash to institute a dividend and share buybacks, continue an aggressive acquisition strategy (which could lead to the next "Big Thing") as well as finance internal projects which should pay off over time. It only takes a bit of optimism regarding the Google story to come up with much higher share price projections.
The bottom line is that investors who believe in Google's culture, pedigree, brand, and ability to create vast future revenue streams through innovation can have all of that at a very reasonable valuation. In fact, investors would be hard-pressed to find another stock that shares Google's high-quality, conservative valuation and potential upside. On a risk/reward basis this is one of the most attractive large-cap names in the market.
On a final note, while past performance may not be indicative of future returns, it can be used as a reasonable metric to assess the performance of the business and management over time. Since going public in 2004, Google has climbed around 538 percent versus a gain for the SPDR S&P 500 ETF (NYSE: SPY) of 34 percent. Look for this dramatic outperformance to continue going forward.
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