GOOGLE INC. (Nasdaq symbols GOOG $588 (class C: nonvoting) and GOOGL $598 (class A: one vote per share); Aggressive Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 676.4 million; Market cap: $397.7 billion; Price-to-sales ratio: 6.1; No dividends paid; TSINetwork Rating: Above Average; www.google.com) operates the world’s leading Internet search service. The company has about 70% of this market, mainly because its innovative technology helps users quickly find the information they’re seeking. The U.S. supplies 45% of Google’s revenue.
The company gets about 95% of its revenue by selling advertising on its websites. It mainly does this with its AdWords program.
Using AdWords, advertisers bid on certain search words or phrases. The company then charges advertisers when users click on their ads.
Google also offers several other free services, including Gmail (email), YouTube (videos), Google+ (social networking) and Google Chrome (a web browser). These features draw more users to Google’s sites, which lets it sell more ads and charge higher ad rates.
In addition, the company continues to profit from its Android mobile operating system. Smartphone makers can use this software for free, but thanks to strong demand, it now powers 85% of the world’s mobile devices.
Adapting to the mobile shift
Advertisers pay lower rates for mobile ads, as they are harder to see on these devices’ smaller screens than on desktops and laptops. In response, Google is now forcing advertisers to buy ads for a variety of devices instead of letting them choose between desktop and mobile platforms. This should help stabilize the company’s ad rates.
Google recently agreed to sell its money-losing Motorola Mobility smartphone manufacturing business to Chinese computer maker Lenovo Group for $2.9 billion.
However, Google is keeping Motorola’s patent portfolio, which should provide steady licensing revenue and help shield the company from lawsuits launched by competitors. Google expects to complete the sale by the end of 2014.
Meanwhile, Google recently teamed up with three smartphone makers to launch Android One, a device for emerging markets that will cost around $100. Fewer than 25% of people in developing countries currently own a smartphone, compared to over 50% in developed nations, so demand for these devices could be huge.
Google’s revenue shot up 152.9% from $23.7 billion in 2009 to $59.8 billion in 2013. Earnings jumped 87.3%, from $6.5 billion to $12.2 billion. Per-share earnings rose at a slower pace of 76.6%, from $10.21 to $18.03, on more shares outstanding (all per-share amounts adjusted for a 2-for-1 stock split in April 2014).
The company spent $8.0 billion (or 13.3% of its revenue) on research in 2013, up 17.1% from $6.8 billion (or 13.5% of revenue) in 2012.
Growing beyond search
In addition to improving the performance of its search engine, Google is working on a variety of other technologies aimed at cutting its reliance on online advertising, including self-driving cars, unmanned delivery drones and Google Glass, a pair of eyeglasses with embedded computer displays.
As well, Google recently paid $3.2 billion for Nest Labs, which makes thermostats that cut heating and cooling costs by adjusting a home’s temperature depending on the time of day, occupants’habits and other factors. Nest also recently started selling a smoke alarm/carbon monoxide detector.
Google will likely use Nest’s technology to build more products, like home entertainment systems. Linking all of these devices to the web could drive more traffic to YouTube and Google’s other sites.
In addition, Google has formed a joint venture with drug maker AbbVie (New York symbol ABBV). The companies plan to each invest up to $500 million to research new treatments for cancer and neurodegenerative diseases like Alzheimer’s and Parkinson’s.
Google also has an alliance with Switzerland-based Novartis to develop contact lenses that can monitor diabetics’blood sugar levels through their eyes.
It could take years to these projects to pay off, if they ever do. But Google can afford to be patient. As of June 30, 2014, it held cash and investments of $63.6 billion, or $94.12 a share. Its long-term debt is just $3.2 billion, or 1% of its market cap.
Go with the class C non-voters
The class C stock trades at 26.7 times the $22.03 a share that Google should earn in 2014. But its 2015 earnings could rise to $26.38 a share, and the stock trades at a more reasonable 22.3 times that forecast.
Shareholders should keep holding their class A stock, but we recommend the cheaper class C nonvoting shares for new buying.
Google is a buy.
