Search No More: Google’s a Value Stock

Google’s (GOOG) stock has been punished thus far in calendar 2010 falling more than 20% from its 52-week high.  Some of that can be blamed on the recent correction, but with the broad market indexes just about even for the year there is obviously something more.  Much of the pessimism towards the internet search giant is related to its pull back from the lucrative Chinese market after a throw down over censorship, and Google’s pain has been Baidu‘s (BIDU) gain as their shares have grown nearly 80% already this year.  Some of this shift in valuation is certainly warranted, especially for Baidu, however we think that the reaction has created an opportunity to pick up shares of the global leader in search advertising.

A recent info-graphic provided through Barry Ritholtz’s blog shows the degree to which “googling” has gone global (all statistics are as of February 2010).  In the US, Google claims an impressive 72% percent of search market share despite established competition.  However, to the south Google’s market share is stronger with Mexico and all of South America hovering around 90%.  Google has all but squeezed out the competition in such European countries as the Netherlands, Belgium, Latvia, Lituania, Hungary, Romania, and Poland all with greater than 95% share.  Interestingly, as of the time of the report, Google only claimed 26% of Chinese searches, but 81% from India.

A recent report out of Google claims the company generated $54 billion in US economic activity in 2009, apparently this tabulation accounts for revenues generated through ads placed by on Google search results (as opposed to being Google’s own revenue).  The report laid out the value proposition for using their platform, “We conservatively estimate that for every $1 a business spends on AdWords, they receive an average of $8 in profit through Google Search and AdWords.”  It would seem to me profit is the wrong term to use in this case, but you get the idea; the platform works.

Clearly, internet search advertising is dominated by Google, and we have seen spending return as the economy has rebounded.  We believe this trend will continue as keyword targeted advertising has become a key medium for small business ad campaigns, and economic recoveries are a time when many small businesses get off the ground.  According to ZenithOptimedia, a London-based ad buyer, the internet’s share of overall advertising spending is expected to grow to 17% in 2010 from 13% last year.

So, is the China ordeal a red herring?  We think it is, as the bigger picture is much more positive.  Remember, Google has plenty of other businesses that are rolling along nicely.  Their Android operating system has stormed the smartphone market and in a matter of months has surpassed the iPhone for smartphone marketshare in the US already claiming 28%, and its gaining on the leader Research in Motion (RIMM) quickly.  Coincidentally, just today Google completed its acquisition of mobile advertising firm AdMob, which almost assures Google will be a key player in the rapidly expanding mobile search and advertising business.  Consider this, mobile searching from Android devices, iPhones and Palm’s Pre rose 62% in the first quarter of this year sequentially from the last three months of 2009!

In the interest of brevity, we will not go into other high growth potential initiatives going on at Google right now, such as Google TV.  At this point, we think it would be best to talk about the fundamentals of the company.  Google may sound expensive at nearly $500 per share, but according to our valuation methodology the company is Undervalued.  For example, Google has historically traded for price-to-cash earnings ranging from 25.6x to 52.3x, but using current estimates for this year that metric dips to just 17.5x.  This valuation only becomes more attractive should you choose to back out the $83 per share of cash and equivalents on their balance sheet (with zero debt).  The current price-to-sales per share of 7.3x while high, does not fall out of line with GOOG’s historical norms for price-to-sales of 6.1x to 12.5x.

Based on our analysis the stock appears priced attractively, and has plenty of growth potential in the years ahead with or without China in the picture.  We are reiterating our Undervalued stance as of this week’s report, and we see this stock as a best of breed technology stock that has fallen out of favor because of a relatively minor scuffle (albeit noteworthy for many other reasons).  After all, the fundamental growth continues to impress us and they have built a pretty high moat around their market share in some exciting spaces.

About Ockham Research 645 Articles

Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

We utilize this straightforward approach to value over 5500 securities, with key emphasis given to the study of individual securities' price-to-sales, price-to-cash earnings and other historical valuation ranges. Our long term value investing methodology is powered by the teachings of Ben Graham and it has proven to be very adept at identifying stock prices that are out of line with fundamental factors.

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