Google - Solid Results, Continued Focus On Innovation Still Leaves Long-Term Appeal

Jul.18.14 | About: Alphabet Inc. (GOOG)

Summary

Google reported second quarter earnings which were in line with expectations.

The company continues to grow rapidly and continues to innovate even into ¨crazy¨ ideas.

The strong culture and modest valuation at 25 times earnings still implies that better days might be ahead.

Google (NASDAQ:GOOG) continues to report very strong and healthy sales growth as analysts were slightly disappointed by reported profits. That is not a worry to me given the relentless focus on future growth opportunities and the very strong and healthy culture of the company, having a strong tolerance to failure.

There are no big surprises in the earnings report, as Google still remains an attractive investment opportunity for the very long haul, driven by its strong track record, great management, strong innovative culture and strong financial position.

Highlights Of The Second Quarter

Google posted second quarter revenues of $15.95 billion which is up by 21.7% compared to last year. Sales excluding traffic acquisition costs came in at $12.7 billion, comfortably ahead of consensus estimates at $12.3 billion.

Reported net earnings were up by 6.0% to $3.42 billion, with GAAP earnings advancing to $5.07 per share. Note that earnings were aided by gains of $454 million as reported last year by discontinued operations. Adjusted for this, earnings were up by 25.8% compared to last year.

On a non-GAAP basis, earnings came in at $6.08 per share. This is as earnings fell short compared to consensus estimates at $6.24 per share.

Looking Into The Numbers

Google's own websites continue to drive results with revenues being up by 23% to $10.94 billion. Revenues from its own websites now make up 69% of total revenues. Network revenues from partner sites were up by just 7% to $3.42 billion. It gets increasingly cheaper for Google to acquire traffic to its websites. Total traffic acquisition costs made up 22.9% of total advertising revenues, down 210 basis points from last year.

Again growth was driven by Google's own websites like its namesake search engine and Youtube.com, with own websites seeing a 33% increase in the number of clicks while number of member clicks rose by 9%.

Clicks outpaced revenue growth again, with average prices continuing to fall. Part of this reason is of course the continued shift to smart phones on which advertisers are willing to pay less cash. At the same time, the continued increase in the usage of smart phones is cutting Google as the middle men in ¨daily applications¨ with users directly using applications instead of the search engine's services.

Spectacular growth came from ¨other¨ revenues which rose by 53% to $1.60 billion. Unfortunately the company does not further specify this revenue number.

Motorola Mobile posted a $68 million net loss which are recognized as discontinued operations. Of course Google reached an agreement with Lenovo at the start of the year to sell the business.

Valuation

Google ended the quarter with $58.7 billion in cash. Having just $5.2 billion in debt outstanding, Google holds a net cash position of about $53.5 billion.

At $575 per share, Google's equity is valued around $395 billion, which values net operating assets at little over $340 billion. On a trailing basis, Google has now posted sales of about $63 billion as trailing earnings have come in around $13.2 billion.

This values operating assets at around 5.4 times annual sales and 25-26 times trailing earnings.

Continued Growth Prospects After A Terrific Decade

Given the size of Google it is astonishing to see the business still growing at rates above 20%. After posting revenues of merely $3.2 billion in 2004, the company has roughly twenty-folded its revenues between now and then, increasing sales by an average of around 40% per annum.

Earnings have grown at a similar pace, while the total dilution of the shareholder base was limited to about 25%. While growth prospects might still be very good, it will be hard to replicate these growth percentages going forwards.

Originally the company has of course solely focused on search with the related advertising revenues being generated from these operations being the major cash cow of the business. With these funds the company has financed the entry into other areas which can bring future growth. Past successful investments of course include Youtube.com and Android, while many of these investment areas will still have to pay off as discussed next.

Takeaway For Investors

The near monopoly in search has made Google one of the most valuable companies in the world. At the same time, its founders should be applauded for embracing failures and trying to make bold moves in other areas in order to change the world.

This philosophy and culture as well as the pay has made the company one of the most desirable places to work. Stock-based compensation, which is estimated at around $3.4 billion for this year, amounts to roughly $70,000 per average worker a year on top of the regular paycheck.

Another high profile news event was the fact that former Ford (NYSE:F) CEO Alan Mullaly is joining Google's board, perhaps motivated by the usage of Android in cars and the company's ambitions for driverless cars. As known, management changes happen frequently at the company to ensure having a fresh look on each business. On Thursday Google also announced that Nikesh Arora will join Japanese Softbank to aid that company in its expansion efforts.

Other areas of focus include of course Android which Google has not even monetized. Besides its dominant position in smart phones, the company aims to use the technology as operating system for cars but also household appliances and watches, among others. The purchase of Nest should also be seen in the light of this, creating the ¨smarter¨ home.

Other initiatives include the company's built of a high-speed fiber network, robotics but also bold projects like Google glass and space travel. Its project ¨Loon¨ aims to make the company a truly global company, aiming to bring internet access to 5 billion global consumers which are still not online.

As such Google is no longer the core search business, although it generates the vast majority of revenues and earnings from this near monopoly. It continues to blend the media, automotive and technology landscape. The very strong cash position allows the company to invest in the long term and it is evident that management is in it for the long run, as their personal wealth is incredible.

As such the valuation at 25 times earnings after backing out cash, is actually overstates to some extent as Google is throwing in billions in these ¨crazy¨ investments per year. This is being done, to make sure they catch the next ¨big thing¨. Shares trade close to all time highs and in hindsight the correction to $500 in May was a great entry opportunity. Yet on dips, shares still overall appeal for long term investors. I certainly believe that better days are ahead.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.