ByHoward Reisman:
On July 19th we wrote
"Why You Should Buy Google In Advance Of Earnings
And Hold It For At Least Six Months."
Well, it has been around 3½ months and the call looks pretty good.
When we published the article, Google (
GOOG
) was around $590 and is currently around $682 as I write this. So
a gain of around 16% vs. 3% for the S&P 500. Not bad. If we
were smart enough to write a blog entry on October 5th rather than
today, we could have been crowing about a gain of almost 24%, as
the stock briefly flirted with $774 before profit taking and then a
disappointing earnings report set in.
Google Price Performance vs. the S&P 500
(click to enlarge)
The last blog was based entirely on technicals and is an
interesting read in its own right. However, if we are going to
consider what to make of Google for the future, especially given
the run up, it is best to consider all of the factors that come
into play: technicals, fundamentals and the business story.
Looking at the last factor first, there are a number of cross
currents with the Google business story and they are hard to read.
To wit, the Motorola purchase - good move, or giant distraction and
cash drain? Monetizing mobile - new growth story, or a story of
secular decline for traditional search? Management - focused, or
all over the map?
On the fundamental side. Is it a story of slowing revenue growth
and rising expenses? Or a plateau before the ascent of Mt.
Mobile?
Google - Rising Expenses and Slowing Revenue
Growth
(click to enlarge)
Finally, the technicals. Do we have a broken stock or a
consolidating stock. Let's drill a little deeper.
The Business Story
Let's take a look at each area in turn, beginning with the
business story. The big move for Google was purchasing Motorola
Mobility for 12.5 billion dollars. Clearly a high margin software
business buying an also ran low margin hardware business with
negative cash flow and the possibility of alienating key partners
doesn't make a whole lot of sense. Two explanations here. One, we
need those patents (most likely) or two, we are not very smart
managers (not likely). The third possibility of resuscitating the
company and having it contribute meaningfully to the bottom line is
quite remote. Pluto remote. So they made a strategic choice, using
their capital to buy a large patent portfolio to help protect
Android. All the while hoping to run it so as not to burn too much
more capital in the future. This was a one off. And for a big deal,
it is not a big deal since it's not where Google's future
trajectory is defined.
Google Net Margin - Motorola has changed things
(click to enlarge)
The big deal is search. How are the markets and the monetization
of those markets changing? Is Mobile the next great growth story or
a destroyer of the traditional search model? Let's take a look. The
annual revenue run rate of Google mobile is currently around 8
billion and growing rapidly (220% year over year increase). Mobile
now accounts for approximately 17% of core revenue. Overall core
revenue increased in the neighborhood of 20% vs. last year.
Analysts project core revenue growth at mid, high teens going
forward. Mobile is it infancy as far as monetizing search goes.
Android is the dominant smartphone OS, accounting for around 75% of
worldwide smartphone activations last quarter. Google claims over
one million activations per day. While Google gets no direct
revenue for this, the dominance and the search revenue potential
cannot be ignored.
Google Earnings - Past, Present and Future
(click to enlarge)
Google is a large diverse company with many R&D efforts and
potential revenue streams being developed (Google Docs, Google
Play, Chromebooks etc.) all of which could be meaningful growers in
the future. However, with the potential of mobile search alone,
which could kick core growth up even higher than the mid teens,
it's hard not to like the story.
The Fundamentals
So now, let's take a quick look at fundamentals, starting with
sales. Note that approximately $5B of the increase in sales for
next year can be attributed to a full year with Motorola.
(click to enlarge)
Revenue has grown strongly and that trend is expected to
continue into the future. Revenue growth tends to be in the
neighborhood of 20% per year give or take. That is impressive. What
is even more impressive is their expense growth. If you look at the
table below, you will see that their net income is increasing at a
slower pace than revenue growth, especially recently. This is due
to the faster rate of expense ramp relative to revenue.
Google Bottom Line Growth is Slower Than Revenue
Growth
Google spends a lot of money. They spend it on product
development, on data centers, on hiring, on stock based
compensation, on new initiatives, on acquisitions. They invest
heavily in their future. With the increasing river of cash coming
in from their core businesses, they certainly can afford to do it.
The efficiency and return on their investments will be key factors
in the company's financial and stock performance in the future. At
the end of the day, you have to decide how much confidence you have
in the management team as efficient stewards of capital. So far, it
is hard to argue with the results.
Let's take a quick look at valuation.
(click to enlarge)
The stock trades roughly at historical norms, around 20x
trailing P/E. Cash per share is rising significantly and
approximately 20% of the market cap is in cash. So while Google the
stock is far from cheap, it isn't expensive either, and is trading
well within historical norms.
Google's P/E Over Time
(click to enlarge)
The Technicals
Finally the technicals. Looking at a six-month chart, we see a
big drop after the latest earnings release, which reverted the
stock back to trendline. There appears to be strong support around
$660, and according to the RSI, we have a greatly oversold stock.
So while technicals are never a sure thing, and can be interpreted
in different ways, a strong case can be made for consolidation vs.
further deterioration.
(click to enlarge)
In Conclusion
So to sum up, a strong business story, punctuated by a potential
dominating position in the next big area, mobile search. Valuation
is fair, neither cheap nor historically expensive. Technicals
looking like they may be consolidating for the next move up. For me
it comes down to management. If management can be trusted to invest
their torrent of cash flow wisely, it is hard not to like Google
for the long term. If your view of management is less favorable,
then the rapid rate of expense rise vs. revenue and the distraction
of Motorola Mobility would be of great concern. The stock will
start to look expensive if management fails to grow the revenue
side as well as the market expects.
Me, I am betting on management. I view Google as a long-term
core holding for growth oriented investors.
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. I have no business relationship with
any company whose stock is mentioned in this article.
See also
Wal-Mart - Short Term Weakness Gives Investors An
Excellent Entry Point
on seekingalpha.com