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Monday, January 14, 2013

Google: Dominance, Growth and Cheap Valuation

originally appeared on The Motley Fool on NBC News:

Google has been one of the tech industry’s incredible growth stories.  Since going public in 2004 for $85, shares have increased in value by an outstanding 770%, and many analysts and investors (myself included) think there are even more gains ahead.  When the company reports earnings on Jan. 22, the market will be looking for signs that signal just that.

Google has grown to be the world’s largest Internet company, and their mission is to organize all of the world’s information and make it accessible and useful to everyone.  The next two largest competitors in the search segment are Yahoo with a market cap about one-ninth of Google’s, and Microsoft, whose Bing search engine is gaining popularity. These two companies made a deal in 2009 with the goal of challenging Google’s dominance.

Under the deal, the companies will maintain their own branding, however Yahoo search results say “powered by Bing.”  Microsoft then pays Yahoo 88% of the revenue it gains from Yahoo searches.  According to comScore, the results of their partnership have been mixed, with Bing up but Yahoo down.  For the month of November 2012, the latest month with data available, Google took a record 67% of all U.S. search traffic, followed by Bing’s 16.2% and Yahoo’s 12.1%.  Look for Google to address their rising market share and possibly for plans to reach their 70% market share goal during the earnings call.

Google has grown by leaps and bounds over the past decade, branching out from being just an online search company by entering several other segments.  For instance, in recent years they have launched an email service (Gmail), mapping services (Google Maps and Google Earth), a finance site (Google Finance), a mobile software platform (Android), its own web browser (Chrome), a social network (Google +), and a tablet computer (Nexus).  These ventures have added to one another in the same way that Apple’s products have.  I certainly know more people with a MacBook, iPad, iPhone, and iPod than I do with just any one of those.

By the same method, many people who use Gmail also use Google’s search engine, Google Finance to check stock quotes, and Google Maps to get directions. The company also has partnership deals with such companies as eBay, which makes Google the exclusive provider of text-based ads for eBay outside of the U.S., and with Dell, which pre-loads Dell’s PC’s with the Google toolbar as well as a co-branded homepage.

Google has grown its earnings tremendously (see chart below), and analysts seem to think this will continue.  The consensus calls for $39.84 per share when the company reports next week, so Google currently trades for 18.6 times 2012 earnings, which is a bargain considering two things: cash and growth.  First the cash: Google has a stockpile of $44.6 billion in cash.  So, excluding cash the market values Google’s business alone at $198.6 billion.  In other words, of Google’s share price ($739.99 as of this writing), only $604.38 of that represents Google’s business and future growth, and the rest represents cash in Google’s bank accounts.  So, the business itself trades at only 15.2 times earnings, which sounds much cheaper.

Additionally, Google’s earnings are forecast to grow to $46.31 and $54.84 per share in 2013 and 2014, respectively.  This implies annual earnings growth of 16.2% and 18.4% for the next two years.  I would anticipate a jump in share price if the company’s numbers and future outlook reflect similar numbers when they report.  A P/E ratio of 15.2 is far too low for a company that is still growing like this!

To sum it up, Google has a lot going for it that should translate into earnings growth in the year ahead.  In addition to being absolutely dominant in the online search segment, they are gaining market share in the tablet PC, operating system, smartphone, and social networking segments.  More importantly than the 2012 earnings numbers themselves, investors should pay close attention to any updates given by the company on these new frontiers of Google’s business, as they will be key drivers of growth over the next several years and beyond.