Google: Is It A Buy?

Google Valuation

Google (NASDAQ:GOOG), the leader in online search, has been among the top stock picks of Amigobulls for over three quarters now. The stock is up over 28.05% since we first picked it up. As we enter 2014, we release an update on the stock with our latest valuations based on the future growth and earnings expectations of the firm. However, before we look at the future potential, we take a look at the Google’s historical performance.

Google Revenue Growth and Earnings

The chart below displays the company’s year-on-year (Y/Y) revenue and earnings growth rate over the last eight quarters.

Revenue and earnings growth rate

Based on numbers reported in Google Income statement

The company has seen a decline in revenue growth rate following the Motorola acquisition in May 2012. The acquired segment has been a drag on the company’s overall growth and has to grow its revenues significantly beyond its current levels in order to justify its $12.5 billion price tag. We expect the unit to generate just over $5 billion in 2013. On the positive side for the search business, Q3 saw the company report a substantial increase in paid clicks, which went up by 26% on a Y/Y basis. Another positive from the last quarter was the margin expansions which lead to a substantial increase in the earnings inspite of a slower growth in revenues. The operating profit margin as well as the Net Income margin saw an improvement of 4 percentage points over the year ago quarter. The chart below shows the profit levels of the company over the last 8 quarters.

Google profit margins

Based on numbers reported in Google Income statement

The company has seen a fall in margins following the acquisition of Motorola Mobility (hardware) due to the acquired division’s losses, which have been a drag on Google’s overall margins. The division had an operating margin of -27% in Q3 2013, compared to the search segment’s 33% operating margin.  The hardware division saw a two percentage margin improvement over the year ago quarter. A successful turnaround of the hardware division and its resulting profitability could boost future overall margins at Google, which will have a positive impact on the earnings.

We now take a look at the free cash flow (FCF) margin which the company has generated over each of the last eight quarters. The company’s free cash flow margin has consistently been close to 20%, averaging over 23% for the last eight quarters. This is an indicator of the firm’s ability to convert its revenues to cash, a fact immensely valued at Amigobulls.

Google Free cashflow margin

The historical performance of the company makes one point clear. The Motorola acquisition is yet to prove its worth in operational terms, though the worth of the acquired patents could be another ball game altogether. Google will have to find ways to turnaround the acquired division so that the acquisition will be directly accretive to Google’s future earnings.

Where is Google headed? Our future estimates

Let’s now take a look at the company’s future potential and expected valuation of the company’s intrinsic value. We expect the company’s future growth to be fuelled by two facts. The growth of internet in terms of penetration isn’t slowing down, and Google’s cash cow of online search business will continue to sing along as long as worldwide internet penetration is on a rise. The only concern will be a major economic slowdown in world economy which typically results in lower ad spends.

The recent launch of Google Compute Engine (GCE) is another product we will be closely following, as this could add significantly to Google's revenues. To give a comparison, Amazon web services is turning in over a billion dollars in quarterly revenues. Considering the size and scope of GCE, investors can expect similar revenues from Google’s new service. Also Google’s focus on innovation resulting in new products like Google glass and driverless cars make the company an interesting and tricky bet.

We shall now estimate the future revenues and earnings of Google based on our expectations and past performance. The table below summarizes our estimates of Google’s revenue and earnings growth up to 2015.

2010 2011 2012 2013E 2014E 2015E
Revenue Growth 24% 29.3% 32.4% 18% 18% 18%
Revenue (in millions of USD) 29,320 37,905 50,175 59,206.5 69,863.7 82,439.1
Operating Margin 28.3% 27.4% 23.2% 23% 20% 20%
Operating Income 8,312.19 10,381 11,632 13,617.5 13,972.73 16,487.83
Net Income Margin 29% 25.7% 21.5% 22% 22% 22%
Net Income (in millions of USD) 8,505 9,737 10,788 13,025 15,370.01 18,136.61
Number of shares 323 327 332 336 340 344
EPS Growth 28.9% 13.1% 9.1% 19.4% 16.6% 16.6%
EPS 26.31 29.76 32.46 38.77 45.21 52.72

E: Estimates

Our average revenue growth rate of 18% is significantly lower than Google’s three year average growth of 29%. The reduced growth is a conservative estimate. The growth rate could go north depending on Google’s ability to turnaround its hardware division and grow its new products. A keenly observed number in Q4 will be the growth in online search revenue.

Our intrinsic value of Google is based on the 2015 numbers. The table below summarizes our estimate of Google’s intrinsic value.

Google Intrinsic Value Estimate

2015 EPS $52.72
Current stock price (As of Jan 7, 2014) $1,138.86
Forward price/earnings ratio 21.60
Estimated price/earnings ratio 26
2 year target stock price $1,370.72

Our target price of $1370.72 represents an yearly gain of 10%, and considering 8% as an average rate of return for an equity investor, the margin of safety is very low. While we remain bullish on the company’s prospects, getting in at its current price levels will not result in any extraordinary returns.

To see Google’s latest stock price movement, click here (NASDAQ:GOOG)

Virendra Singh Chauhan Virendra Singh Chauhan   on Amigobulls :

Neither Amigobulls, nor any members of its staff hold positions in any of the stocks discussed in this post. The author may not be a certified/registered investment advisor, and the opinions expressed should not be treated as investment advice.

Buying and selling of securities carries the risk of monetary losses.Readers/Viewers are advised to carry out their own due diligence and consult their investment advisors before making any investment decisions.

Neither Amigobulls, nor the author have any business relationship with any of the companies covered in this post.

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