Google: Innovating Beyond Advertising And Search

| About: Alphabet Inc. (GOOG)

Google Inc. (NASDAQ:GOOG) is primarily known as a leading advertising company based upon its proprietary search, which fits nicely with its goal of organizing the world's information. Google has further diversified into a range of products and services. However, many of these endeavors do not directly generate revenue. Another widely discussed aspect of Google is its policy of allowing engineers to spend 20% of their time on personal projects. These projects have generated many useful applications, ranging from Gmail to Google Talk.

Google trades at a slight premium to market

Without question these side projects should help Google grow its financials and provide upside to shareholders. In 2011, Google posted $37.9 billion in revenue. With a current market capitalization of $222 billion and an enterprise value of $188, Google trades a trailing twelve months PE ratio of 20.1x (about 25% premium to the S&P 500) and has an enterprise value to EBITDA ratio of 12.9. However, its forward PE ratio of 13.8x is just an 8% premium to that of the S&P 500.

Google is investigating several areas beyond advertising, including renewable energy and self-driving cars. I see the latter as a large potential opportunity. Anyone who has driven across the country or been stuck in rush hour traffic can imagine the benefits of this type of technology. It would also have implications for transport and logistics companies like FedEx (NYSE:FDX) and United Parcel Service, Inc. (NYSE:UPS). It could revolutionize the taxi industry. However, these are not the only benefits, self-driving cars would offer significant benefits to the elderly and disabled, providing them with greater freedom and flexibility. The second order effects would also be significant as the sensors and hardware become mass produced their costs would decline significantly, enabling smaller cost autonomous machines.

Self-driving cars could unlock enormous value...

The potential value creation from wide spread use of self-driving cars is enormous. In 2010, Americans drove approximately 1.7 trillion miles with commercial vehicles accounting for another 1.3 trillion. At an average speed of 60 mph, this represents 24 million years of labor. A slower speed would consume even more time. Assuming an average wage of $20,000 per year, this would be a $500 billion drain on potential output. One can argue that not all driving time should be viewed as a total loss, some people enjoy driving and others find ways to make the time more productive (think audio books, not texting friends). This could improve overall productivity of labor markets if even a portion driving time could be replaced with more useful activities.

The size of the market could be quite significant, with 12.8 million cars and light trucks sold in 2011. Considering 10% penetration with an estimate revenue component of $2,000, this would be $2.6 billion in revenue. The $2,000 premium is also quite reasonable when one considers that the average driver spends over 100 hours a year commuting. Valuing the driver's time at $20 per hour would give a payback period of just one year - both of which are very reasonable assumptions. Most likely targets would be commuters with longer commutes. The product itself would most likely be supplied to the OEMs like Ford Motor (NYSE:F) or General Motors Company (NYSE:GM) but at a purchaser's option. Given that the technology would require proprietary hardware and software that is not common, Google could probably charge a price to reflect the value delivered to the customer - allowing prices to rise higher. There is also a substantial potential market for commercial vehicles.

...while transforming labor markets

Self-driving cars would also impact the existing labor market. Throughout history, capital has been slowly replacing labor. The industrialization of agriculture has reduced the percentage of people in agriculture from abut 40% in 1900 to low single digits in the U.S. today. Manufacturing industries, especially the automobile industry, have seen their work forces shrink, despite rising output. This same effect would ripple through multiple industries, including delivery services like FDX, freight haulers, and taxi cab services. Imagine Zipcar Inc. (ZIP)'s cars arriving at your front door to take you to the store or anywhere else. Once again, capital would displace labor with truck drivers and taxi cab drivers being impacted.

Do I expect the full range of changes to be around the corner? No. However, I would expect them to arrive within 5-15 years. There is also a distinction between a self-driving car that is occupied and an autonomous car. The latter will face higher hurdles but should also become a reality. In fact, Nevada has already legalized self driving cars back in June 2011 and is currently working on regulations. I'm looking forward to the day when I can send my car to fill itself up with gas and get washed and then come pick me up.

From an investment perspective, Google seems like an attractive long opportunity. Its work in a range of areas that have huge potential and strong record of growth should justify more than an 8% premium to the broader market.

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

Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.