For investors looking for a large-cap tech company with a history of increasing growth coupled with long-term growth potential, Google Inc. (GOOG) is a company worth further investigation.
Google, Inc. is a web search and online advertising company that focuses on search, advertising, operating systems and platforms, enterprise and hardware products.
In the section below, I will analyze aspects of Google's past performance. From this evaluation, we will be able to see how Google has fared over the past four years regarding their profitability, debt and capital, and operating efficiency. Based on this information, we will look for strengths and weaknesses in the company's fundamentals. This should give us an understanding of how the company has fared over the past few years and will give us an idea of what to expect in the future.
Profitability
Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.
- Net income 2010 = $8.505 billion
- Net income 2011 = $9.737 billion
- Net income 2012 = $10.737 billion
- Net income 2013 TTM = $12.430 billion
Over the past four years, Google's net profits have increased from $8.505 billion in 2010, to $12.430 billion in 2013 TTM, which represents a 46.20% increase.
- Operating income 2010 = $10.381 billion
- Operating income 2011 = $11.742 billion
- Operating income 2012 = $12.760 billion
- Operating income 2013 TTM = $13.438 billion
Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.
Over the past three years, Google's operating income has increased from $10.381 billion to $13.438 billion in 2013 TTM. This represents an increase of 29.45%.
ROE - Return on Equity
As shareholders' equity is measured as a firm's total assets minus its total liabilities, ROE reveals the amount of net income returned as a percentage of shareholders' equity. The return on equity measures a company's profitability by revealing how much profit it generates with the amount shareholders have invested.
Net Income / Shareholders' Equity
- 2010 - $ 8.505 billion / $ 46.241 billion = 18.39%
- 2011 - $ 9.737 billion / $ 58.145 billion = 16.75%
- 2012 - $ 10.737 billion / $ 71.715 billion = 14.97%
- 2013 TTM - $ 12.430 billion / $ 82.989 billion = 14.98%
Over the past four years the ROE is showing decreased. Since 2010 the ROE has decreased from 18.39% to 14.98% . As the ROE has decreased over the past four years, this reveals that there has been a decrease in how much profit has been generated compared to the amount that shareholders have invested, thus indicating an increase in shareholder value.
Debt And Capital
The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.
Total Liabilities To Total Assets, Or TL/A ratio
TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.
Total assets
- Total assets 2010 = $57.851 billion
- Total assets 2011 = $72.574 billion.
- Total assets 2012 = $93.798 billion.
- Total assets 2013 TTM = $105.068 billion.
- Equals an increase of $47.217 billion
Total liabilities
- Total liabilities 2010 = $11.610 billion
- Total liabilities 2011 = $14.429 billion
- Total liabilities 2012 = $22.083 billion
- Total liabilities 2013 TTM = $22.079 billion
- Equals an increase of $10.469 billion
Over the past three and a half years, Google's total assets have increased by $47.217 billion, while the total liabilities have increased by $10.469 billion. This indicates that the company's assets have increased more than the liabilities thus adding shareholder value.
Working Capital
Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.
Current Ratio = Current assets / Current liabilities
Current assets
- Current assets 2010 = $41.562 billion
- Current assets 2011 = $52.758 billion
- Current assets 2012 = $60.454 billion
- Current assets 2013 TTM = $68.858 billion
Current liabilities
- Current liabilities 2010 = $9.996 billion
- Current liabilities 2011 = $8.913 billion
- Current liabilities 2012 = $14.337 billion
- Current liabilities 2013 TTM = $14.475 billion
- Current ratio 2010 = 4.16
- Current ratio 2011 = 5.92
- Current ratio 2012 = 4.22
- Current ratio 2013 TTM = 4.76
Over the past three and a half years, Google's current ratio has been increasing. As the current ratio is currently well above 1, this indicates that Google would be able to pay off its obligations if they came due at this point.
Common Shares Outstanding
- 2010 shares outstanding = 321.30 million.
- 2011 shares outstanding = 324.89 million.
- 2012 shares outstanding = 329.98 million
- 2013 TTM shares outstanding = 334.16 million
GOOG Shares Outstanding data by YCharts
Over the past three and a half years, the number of company shares has increased. The company shares have increased from 321.30 million to 334.16 million and increase of 4.0%
Operating Efficiency
Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.
Gross Margin: Gross Income/Sales
The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).
- Gross margin 2010 = $18.904 billion / $29.321 billion = 64.47%.
- Gross margin 2011 = $24.717 billion / $37.905 billion = 65.21%.
- Gross margin 2012 = $29.541 billion / $50.175 billion = 58.88%.
- Gross margin 2013 TTM = $32.753 billion / $57.386 billion = 57.07%.
Over the past four years, Google's gross margin has been decreasing. The ratio has decreased from 64.47% in 2010 to 57.07% in 2013 TTM.
Asset Turnover
The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.
Revenue growth
- Revenue 2010 = $29.321 billion
- Revenue 2011 = $37.905 billion
- Revenue 2012 = $50.175 billion
- Revenue 2013 TTM = $57.386 billion
- Equals an increase of 95.72%
Total Asset growth
- Total assets 2010 = $57.851 billion
- Total assets 2011 = $72.574 billion.
- Total assets 2012 = $93.798 billion.
- Total assets 2013 TTM = $105.068 billion.
- Equals an increase of 81.62%.
Over the past three and a half years the revenue growth has increased by 95.72% while the assets have increased by 81.62%. This is an indication that the company from a percentage point of view has been more efficient at generating revenue with its assets.
Based on the information above we can see that Google has had a very strong 4 years. The net income over the past three and a half to four years, have increased by 46.20%, the revenue has almost doubled since 2010, while the company's assets have increased by 81.62%. A couple of blemishes that the analysis reveals are: A decrease in the gross margin and a decrease in the ROE. Over the past four years the gross margin has fallen from 64.47% to 57.07% while the ROE has decreased to 14.98% from 18.39% in 2010.
Catalysts for Growth
With the face of the advertising business changing, companies that are adapting to the increasing use of mobile devices will be the ones that will make the most profits. As advertising is Google's core business, the price that advertisers pay each time someone clicks on an ad is extremely important for the bottom line of the company.
Over the past couple of years the mobile ad market has increased significantly. According to Emarketer, mobile internet ad spending worldwide is expected to top $18.5 billion by the end of 2013. This now accounts for 15.2% of all digital ad dollars spent which is up immensely from 8.2% last year.
Google currently has the market share of the mobile ad dollars but Facebook (FB) is beginning to "make waves" in this space as well. As the chart below indicates, Google currently has 48.76% of the global internet ad dollars but Facebook jumped from 5.34% to almost 17% in just one year.
In the U.S. estimates indicate that internet ad dollars will increase in excess of $14.5 billion by 2017. Mobile ad dollars are expected account for an increasing share of display revenue and represent nearly 50% of the total U.S. display ad dollars by 2017.
As the face of advertising changes, companies who are on the leading edge of the mobile advertising phenomenon should reap the rewards of this transition. As the mobile advertising market both globally and domestically in the U.S. are expected to increase significant this will drive growth for Google into the future.
Valuations
In the section below, I will use a couple of different methods to find a valuation of the stock price. In this section, I will use the Discounted Cash Flow valuation model and forward P/E ratios to estimate the current value of each share.
I believe using the Discounted Cash Flow valuation model for Google to be fair because DCF analysis can help one see where the company's value is coming from and one can generate an opinion based on that.
(click to enlarge)
Even though there are variations in calculating this formula, this model is based off of a terminal value of $363.174B and a WACC of 6.53%. The terminal value $363.174B is based off of the company trading at 21X EBITDA. Personally I can't justify any more than 21x EBITDA as forward P/E ratio is estimated at 21.35. The EBITDA should trade at a discount to this value. Using the valuations above, I have concluded Google's current value to be $1083.27 per share.
Looking forward to 2014, I will use Google's forward P/E ratios with estimated earnings to find the value. Currently, Google has a forward P/E of 21.35 and FY 2016 earnings projected at $60.74. These two metrics lead to a target price of $1296.80.
As of December 21th, Google's stock was trading at $1100.62 - Using the Discount Cash Flow Formula, this indicates the stock is currently overvalued by 1.59%. Looking forward to 2014, If I calculate a valuation using a forward P/E of 21.35 ratios this indicates a valuation $1296.80 or a discount of 17.82%.
Support and Resistance
In a recent article, I analyzed some areas of support and resistance for the stock. According to the article a key support level is around the $1040 range as this represents a very reasonable valuation of 20x EBITDA.
On the upside, as the stock surpassed the price target of $1083.27 per share which represents 21x EBITDA, the next level of resistance should occur around $1126.00.
Strategy
At this point in the market, I would not be surprised if there was a 5-10% correction in January as the Santa Clause Rally ends. If such a correction were to occur, this could present an excellent opportunity to add positions in a company with excellent growth prospects. Currently, I believe there is further upside to equity markets as major world economies are either recovering or on the verge of recovering. As interest rates continue to remain near zero this should favor equities.
Conclusion
Currently, I have a hard time valuing the stock any higher than 21X EBITDA which indicates a value of $1083.27. Having stated that, as the mobile advertising dollars add to the growth of the company, earnings per share growth is expected to increase significantly over the next couple of years. As estimates indicate that Google will produce an EPS of $60.74 in 2016 combined with a forward P/E ratio of 21.35 this produces a 2014 target of $1296.80. At current levels using the Discount Cash Flow Formula, I believe the stock is slightly overvalued but any pull-back would represent an excellent long-term buying opportunity.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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