A New And Improved Google

| About: Alphabet Inc. (GOOG)

By Michael Barton

Google’s (NASDAQ:GOOG) business growth continues at a rapid pace, as the company transforms from what most people know it for – the method of searching the web – to a fully diversified technology company. Soon, it could be seen as rivalling Facebook and Linkedin (NYSE:LNKD), Apple (NASDAQ:AAPL) and Research in Motion (RIMM), as well as traditional competitors such as AOL (NYSE:AOL) and Yahoo (NASDAQ:YHOO). If recent company moves are anything to go by, the market needs to start viewing these stocks differently.

GOOG shares are currently trading around $570, and the mean 12 month price target from analysts researching the stock is $731 (28% upside potential). This stock is trading near its 50-day exponential moving average of $575.83 and above its 200-day exponential moving average of $558.18. The stock saw a decline through the second quarter of the year, as it retraced ground from its 12 month high of $642.96 set in February to its 12 month low of $473.02 attained in late June. Progress in the share price has been choppy since then, though company news, and its rapidly changing business direction since October has seen the shares move back into favor amongst investors.

Earnings per share for the last 12 months are $29.34, and these are expected to reach to $43.86 in its next fiscal year (ending Dec 2012). These numbers place the shares on a trailing price to earnings ratio of 19.43, and a forward multiple of 13. This trailing price to earnings ratio is below the sector average of 21.43, and below AOL’s 25.86. Indeed, AOL is trading at a forward price to earnings ratio of 40.09. Even Yahoo (YHOO) is trading on a forward price to earnings ratio of 16.79; its stock price may be being kept afloat by takeover rumors.

Google, of course, pays no dividend, preferring that investors see returns through capital appreciation. The company came to the market in August 2004, with a capitalization of $23 billion. Its current market capitalization is $185 billion. Current operating margin at GOOG is 32.76%, and profit margin is 26.78%, with a return on assets of 11.96% and a return on equity of 19.52%.

GOOG’s last quarterly report showed revenue growth of 33.40% over the same period last year, and it has $42.56 billion of cash, whilst debts stand at just $7.26 billion. Its debt/ equity ratio of 13.24 is more than manageable.

Over the past 12 months, shareholders in GOOG have benefited in line with the broader S&P 500 index, whilst the year’s earlier underperformance against YHOO has reversed recently, as the market has become aware of the more diversified nature of GOOG’s business plan going forward. The shares have twice tried to test the 12-month lows, but both times have moved ahead. Notwithstanding a shock to the market as a whole, the trading pattern of the shares now looks more positive, and this is bolstered by its product news of late:

  • In October, the company announced the launch of its Galaxy Nexus smartphone, partnering with Samsung, and using Google’s ‘Ice Cream Sandwich’ (Android 4) technology. This technology is suitable for both smartphones and tablets;
  • It also has developed file sharing between its phones by tapping them together – a big step up from the battery consuming bluetooth;
  • The company has said that it is seeing over 500,000 of its Galaxy Nexus phones activated daily world-wide;
  • It has added easier access to YouTube, and with its Google Extensions products is offering users a more socially interactive experience, similar to Facebook.
  • Overall, the trading pattern of GOOG shares, along with its strong fundamentals, leads me to consider this is a company that is well-managed on the financial level. Add to the mix its progressive policy on products and technology, as evidenced by recent news, and this is a heady mix for investors. It has the financial muscle, and the position in the market to create a world wide subscriber base to its more community biased offering, which would also allow it to better target advertising and offer this service at premium pricing levels. This could easily rival that of Facebook, which may be coming to the market in an offering that would value the company at a sales to earnings ratio of 23 (compared to Google’s 5+).

Detractors would argue that the company is losing product focus. I say that diversification is key to long term progress. The upside potential for investors in Google is clear for all to see, and Jim Cramer agrees. I rate Google a buy.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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