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Is Google A Good Stock To Buy Right Now?

Google (GOOG) is a technology company which has made its business on finding ways to breach the gaps between people and information. GOOG is primarily involved in advertising, and operating systems, with most of its revenues coming from advertising through its popular service AdWords. We place a very strong buy rating on GOOG that mainly emanates from its leading position in the dot-com arena. This is evident from a high price multiplier than reflects investors’ confidence on the earning quality of the firm.

Google Inc (GOOG)

While we do not expect such a high earning multiplier to prevail over the long term, owing to sizable cash flows and managerial efficiency, we foresee a significant upside to the stock’s current price level. This rating takes into account potential benefits from GOOG’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 place a strong buy on GOOG stock because we believe that its continuous innovation, additions to and extensions of its product mix, and orientation towards satisfying its consumers, will keep GOOG ahead of all Internet information providers in the future, resulting in healthy profit margins.

Key Thesis Points

1. GOOG is the market leader in search engines, with competitor Yahoo (YHOO) trailing behind in second place with a very low percentage of the total market and a relatively weak financial position. GOOG has a net profit margin of 27% as compared to 11.2% for YHOO. 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 GOOG’s profitability going forward. Management efficiency, measured via income per employee and revenue per employee, far outstrips what the industry currently stands at. This just serves to drive home the fact that the company is not only financially sound, but its numbers have a management team and efficient workforce to back them up. Given its recent strategic initiatives, we expect GOOG to strengthen its market share, augmenting its bottom line.

2. GOOG has a stronger liquidity position than 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 management. The increase in current assets has come mainly from the accounts receivables decreasing, thereby improving A/R collection and increasing cash and cash equivalents. On the other hand, GOOG operates with a debt to equity ratio which is slightly lower than the industry’s requirement, which signals that if the need arises, the company would be able to take on more debt, without treading dangerous waters. This financial flexibility places the company far above YHOO. GOOG’s Equity has increased due to an increase in retained earnings, which has been possible mainly because revenues, and hence net income, in FY11 increased from FY10. If more debt is taken on 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 GOOG, which serves to show that the company does not rest easy, but, in fact, it keeps looking for ways to come up with new products for its markets. Increase in these expenses is not only for the expansion of the company’s product portfolio, but also reflects its orientation towards industry dynamics as a whole. To remain the market leader and produce what the consumer wants, GOOG 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 time needs to be the fastest, or else one ends up in a situation like that of Motorola. GOOG 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 which GOOG can use or integrate with its existing products opens up, it goes ahead and grabs it.  This is one of the strongest competencies the company possesses, and it leverages it well. Upcoming plans are to buy Quickoffice, which GOOG will use in sync with Google Docs, and acquire Meebo. With increasing revenues, total assets and equity, improved liquidity, adequate gearing, and no crunch in cash flows, the company’s acquisitions and growth in software for phones, PCs, laptops, social networking and entertainment will be made all the more easy.

Brief Valuation

GOOG is a growth stock with a Price to Book value of 3.07x and a current PE ratio of 17.3, with a 2013 forward PE multiple of around 11.4. The declining PE ratio should not be surprising for the reason that with a company the size of GOOG, we cannot expect a trailing PE ratio to be very high, making it more expensive than GDP of some advanced countries. The Enterprise Value to EBITDA is at an impressive 10, depicting 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 dominating market position, sizable cash flows, and expected PE multiplier, we value GOOG at $750.

Google is a cheap stock with strong growth potential but its rival Apple (AAPL) is even cheaper. Apple’s trailing PE ratio is 14.2 and its 2013 forward PE multiple is 10.8. Yahoo’s trailing PE ratio is 17.7 and forward PE ratio is 13.9. We are bullish about both Apple and Google. These two stocks are also the top 2 most popular stocks among hedge funds (see the 10 most popular stocks among hedge funds).

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