Google's New Facebook Focus Could Shoot Stock Higher

Apr.17.12 | About: Alphabet Inc. (GOOG)

Google (GOOG) is a company synonymous not only with search, but with a search-focused vision of the World Wide Web's present and future. But what is the vision for Google's future, and should you, as an investor, continue to share it?

I certainly would not rush to dump the stock. Google has dominated online search, steadily eating away at Yahoo's (YHOO) market share and generally fending off Microsoft's (MSFT) Bing. Even if we remember Yahoo and Bing's search partnership and add their market shares together, Google still wins: its most recent search share was 66.4%, nearly matching its all-time high of 66.6%, while Bing's was 15.2% and Yahoo!'s was 13.8%. Google usage online is even more impressive, securely above 90%.

YouTube is a clear leader in the category of online video. Gmail and Google Maps enhance the company's overall brand, and Android has a 50% share of the smartphone market, well ahead of Apple's (AAPL) 30%.

Still, Facebook remains a threat to the company's long-term fortunes. Google+, a significant improvement over predecessors Google Wave and Google Buzz, is still not the competitor with Facebook that some investors hoped it would be: while its number of signups is impressive, users spend little time there. Facebook reflects new ways for users to communicate and share media with each other, ways that its social network makes it more equipped to deliver. The possibility of a "Facebook phone" or "Amazon (AMZN) phone" could spell more trouble for Google.

And many of Google's other innovations have sunk completely. Google Catalog, Google Video Player, Google Web Accelerator, Google Checkout and Google Voice Search are just some of Google's notorious bombs. Some of its new initiatives are simply confusing: how exactly will its investment in self-driving cars lead to an increase in search, e-mail or Android use? Google's culture of experimentation has often been cited as a reason for its success, but experimentation can be costly.

Has Google peaked? Let's look at some key metrics. We will be taking much of our data from a recent Motley Fool study, but seasoning it with additional facts and analysis:

Size. Well, no problems here. Google has a market cap of $206 billion, definitely worth bothering with.

Consistency. Are Google's revenues reliable? In the long run, they have been. Revenue has grown consistently in each of the last five years, and so has gross income. Free cash flow has grown in four of those five. The exception was in 2010, and 2011 was an all-time high of $11.3 billion.

Management Stability. Google has changed managers once in the last five years, but the change was a modest one. For most of the company's history, chief executive Eric Schmidt shared many decision-making tasks with company founders Sergey Brin and Larry Page. On April 4, 2011, Schmidt moved to an executive chairman position and Page became CEO.

The principal new features associated with Page's regime are a slight curtailing of Google's experimental side and a growing focus on Facebook. Since it's very difficult to actually beat Facebook at its own game, this has led some investors to question the stock's future.

Stock Stability. Google is 8% more volatile than the market as a whole, and while that reflects some powerful past growth, it has also given investors more than its share of bumps, including a catastrophic 55.5% loss in 2008, which was a rough year on many investments, but Google's single biggest source of revenues, its search-advertising business, was especially vulnerable to downturns like that. Diversification into smartphones, though, is a powerful insulation against the next bearish period.

Valuation. Google's normalized price-to-earnings ratio (current price over the average earnings for the last five years) is 26.10. While some P/E ratios are much more wildly exaggerated in the tech community, this figure still falls about eight points short of ideal.

Dividends. Currently, Google pays no dividends at all. Apple has recently cast aside its long-standing tradition and began paying dividends, so this policy is a bit more likely to change than it has in years past. Still, Google management is famously independent of industry trends, so don't bet your retirement on it.

Recent Growth. Google has not seen much growth in its valuation over the last year (just 9% at this writing), which is unusually cautious by the standards of the overall market (up 13%). Again, Larry Page may be a big part of the reason. Even though his tech pedigree makes him more respected than Schmidt by Google's hardcore fans, he's less charismatic than his predecessor, and his Facebook focus makes Google seem like a silver medalist rather than a gold. Even though Google's total revenues are far above Facebook's, Facebook did surpass its earnings last year in its traditional crown jewel-search advertising-with earnings of $1.73 billion to Google's $1.71 billion.

Public Perception. Google is still one of the top five global brands, according to the Best Global Brands report, behind only Coca-Cola (KO), IBM (IBM) and Microsoft . All three of those competitors have received a fair amount of negative press over the years, but Google has tried to be different. Page wrote recently:

Most large companies are not well-loved. We have always wanted Google to be a company that is deserving of great love.

As long as it continues to be used as a verb, Google seems likely to at least retain its brand awareness. But the challenge is whether it can retain that love as it seeks more information about its users.

Plan for the Future. I started this piece by asking "what is the vision for Google's future?" Larry Page's Facebook focus seems, to many, to be a clue to the answer. Google has profited by using its search service to tell what its advertisers' potential customers are looking for, but Facebook's services tell it much more about how customers live, and that's allowed it to seize that small advantage in ad revenue.

Now, Google wants to learn both, and while Google Plus is still no Facebook, it's a beginning, and Facebook can't even begin to match Google's abilities in search. The Facebook "Like" button and Google's similar "+1" is where the two worlds seem to meet. "Likes" are more popular, but "+1s" are better-integrated into Google's search and social services. The struggle is not one-sided in either direction, but many analysts bet on Google in the end.

The long-term danger is that such a Facebook-focus might compromise Google's primary specialty. It became a success in the early 2000s because it gave users better Internet search than any available, and despite Bing's best efforts, it has retained its reputation for search quality. In some ways, the +1 button is a logical successor to the "link popularity" which drove Google search's early success. But what's popular is not always what is useful, and a search engine that does not filter the opinions of crowds correctly will be neither popular nor useful.

If it stumbles, Bing and newer startups will be right there to pick up the users it loses. Privacy advocates have already expressed concern about this more social focus.

In Conclusion

Google faces enough hard challenges in the next two years; I'd be cautious about buying up much more of the stock, but if you have some, it's worth keeping. I reserve the right to change this to a "buy" any day now. A recent study indicates Google ad revenues will pass Facebook's by 2013, so Page's strategy may be paying off. A decision to pay dividends could also push the stock into a more attractive category quickly. The tech sector moves fast. And during most of its history, so has Google.

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