Google Still Undervalued

| About: Alphabet Inc. (GOOG)

I remember being in college back in 1998, when Yahoo (NASDAQ:YHOO) was the leading search engine. Around the same time, two graduate students at Stanford came up with a better way to search the Internet and started Google (NASDAQ:GOOG).

Now, Google is the number one Internet search engine. Every day, Google processes 1 billion search requests. It’s also the leader in online advertising. And Google’s always looking for new opportunities. Over the past decade, it's bought nearly 100 companies. Almost every time it enters a new market, it becomes the dominant player.

Three things contributed to its success:

1.It buys the best company in the sector. In 2006, it paid $1.65 billion for YouTube. It seemed like a lot of money at the time for a free service. But it's been able to monetize it with online advertising. YouTube also started renting movies, just like Netflix (NASDAQ:NFLX) and Amazon (NASDAQ:AMZN).

2.It develops or buys the technology cheaply, and gives away the service for free. Google paid $80 million to buy Internet telephone technology. It got the technology by buying Grand Central and Gizmo5. That’s 1/100th of what Microsoft (NASDAQ:MSFT) recently paid to buy Skype. And it's already merged the technology with Gmail and Android OS. The technology is Google Voice. It’s free for U.S. calls.

3.Google make its services easy to integrate with other software. Microsoft, Apple (NASDAQ:AAPL) and Sony (NYSE:SNE) don’t do this. They keep their technology secret, and it hurts them in the long run.

Google takes a different approach. For instance, Google opened up its mobile phone platform, Android OS, to programmers, manufacturers and carriers -- and it gave it away for free. Within 18 months, Android OS-based phones have become the largest segment of smart phones. With 33% of the market share, it's even overtaken the Apple iPhone.

And unlike Apple, it's giving a third of the application revenue to the telecomm carriers. Understandably, the telecom companies are falling over each over to support Android phones.

Now Google is entering the laptop sector. It’s releasing the Chromebook, a Google OS-based laptop. It plans to rent it out to students and businesses on three year contracts.

Google has seen amazing growth. But the stock is cheaper than it’s ever been. Google is valued at $172 billion. It has $36 billion in cash, and only $5 billion in debt. In the past 12 months it generated over $31 billion in revenue. Over the past five years, revenue grew at an average rate of 35%, and net income at 42%. But the stock sells for less than 14 times next year’s earnings. Growth companies like these, with little debt and large cash reserves, usually sell for 20-24 times earnings.

The market is undervaluing Google’s future growth. Even at 18 times earnings, Google’s stock is worth 33% more.

I just bought two shares of Google for my Roth IRA account at $525. The only thing preventing me from buying more is the lack of dividends. But the growth is compeling at this price. If the share price drops below $500, I might pick up a few more.

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