- Google's stock is down by 12% in under a month.
- Google is financially robust with accelerating revenue growth.
- Google valuations indicate that it is currently undervalued.
The anticipation builds up as Google (NASDAQ:GOOG) is due to report its earnings this evening, post market hours. While we’ve covered our expectations of Google’s Q3 2014 earnings in our earnings preview, we see an opportunity in Google’s current valuations. Over the last month, markets have retreated on the back of global economic concerns. Google has fallen by close to 12% in less than a month. The company’s sound financials and its current valuations make it an investment worth considering. We see an upside potential of 18% in Google valuations by the end of the year.
While the recent broad based decline in stock prices has served as a correction for some stocks, it has created opportunities for investors in certain others. Google’s sound financials present a compelling case for investment.
Google Revenue Growth
Google’s revenue growth has accelerated over the last year, driven by strong growth in its core and non-core businesses.
Google’s core business revenue or ad revenue has been growing at a faster clip quarter after quarter over the last year. In Q2 2014, Google’s ad-revenue grew at 19% YoY, much higher than the growth of 15% in Q2 2013.
Additionally, Google’s Own & Owned (O&O) sites have been generating a larger share of the total ad revenue. Revenue generated on Google’s ad network (partner sites or publishers who let Google serve ads on their sites), is shared between the publisher and Google. However, when Google earns revenue on its own sites, it gets to keep all of it. So, Google will be happy to generate a larger chunk of its ad-revenue as long as revenue form partner sites also continues to grow.
In Q2 2014, Google’s paid clicks continued to grow, while there was a deceleration in CPC (cost per click) decline rates on Google’s O&O sites. Both of these are positives for Google’s core business.
Google’s non-core business revenue is also poised to grow with the launch of new products like its Google Glass and Android One range of smartphones. We see significant potential in these products, as we’ve discussed in our earlier posts.
Google Profitability & Cash Flows
In Q2 2014, Google’s Non-GAAP EPS expansion fell short of analyst estimates. However, the company’s profit margins were higher than their average levels over the last year. Google’s operating and net profit margins were 26.7% and 21.4% respectively during the quarter.
Some cost components will go off the income statement when Motorola employees eventually seize to be a part of Google’s headcount, and could aid margin expansion. The company generated an operating cash flow of $5.6 billion or 35% of revenue during Q2 2014.
Google is currently trading at a stock price of $540.73. Google’s PE ratio and Price to Sales ratio of 5.8 and 27.9 respectively, are much lower when compared to their average levels over the last twelve months (LTM).
Valued based on its average PE and PS ratios over the last year, Google should be trading at a price of about $580 a share, translating to an upside of a little over 7% from its current price.
Google’s valuations have an even greater potential upside over the coming months. Analysts expect Google to end the year with a revenue and non-GAAP EPS of $66 billion and $26.4 respectively. Google’s projected revenue of $66 billion represents a 19.6% YoY growth over its FY 2013 revenue (excluding Motorola). Google’s average growth rate of 20.4% in FY 2014 so far has been higher than required to meet analysts’ estimates.
Based on its full year revenue and earnings projections, its average PE and PS ratios of 6.3 and 29.7%, Google should trade at $640 a share (average of valuation based on PE & PS) by Jan 2015. At a target price of $640 a share, Google valuations have a potential upside of 18% from its current levels. Google is one of our top stock picks. Our Google stock analysis video covers more fundamental aspects of the company’s business.