Google's Growth Is Slowing But The Stock Is Correctly Priced

| About: Alphabet Inc. (GOOG)

Only a few years ago, Google (NASDAQ:GOOG) was known for its dominance in the search engine industry. The company, however, has successfully diversified its business by venturing into software, mobile operating systems, tablets, cloud computing, and many other technology businesses. Google may have lost its place as the biggest and most innovative technology company in the world, but it still earns solid returns for investors. The ROI is still above 19%, and net profit margin is approximately 50% higher than the industry average of 26%. During the last quarter, Google posted EPS of $10.12, beating consensus estimates of $10.04. The following table shows previous earnings and expectations from Google:

Earnings History

Sep 11

Dec 11

Mar 12

Jun 12

EPS Est

$8.74

$10.50

$9.65

$10.04

EPS Actual

$9.72

$9.50

$10.08

$10.12

Difference

$0.98

$-1.00

$0.43

$0.08

Surprise %

11.20%

-9.50%

4.50%

0.80%

Click to enlarge

Source: Yahoo Finance

As the table given above shows, the company missed analyst expectations in only one of the last four quarters. Average EPS estimates for the current quarter are $10.6.

If we look at Google's valuations and compare them to its competitors, it maintains a good standing. GOOG is trading at higher valuations as compared to Apple, which is trading at P/E of 12.9x. However, if we look at industry benchmark valuations by Reuters, GOOG is trading at P/E of approximately 15x, lower than the industry average, and at a P/S ratio that is 20% higher than the industry.

Company

Forward P/E

P/S

Google

15x

5.7x

Apple (NASDAQ:AAPL)

12.9x

4.4x

Yahoo (YAHOO)

13.3x

3.8x

Microsoft (NASDAQ:MSFT)

9.3x

3.5x

Industry Average (Reuters)

20x

4.8x

Click to enlarge

If we look at the table given below, we can see the revenues that Google has generated from its different segments. Compounded growth in total revenues for the last four years has been 15%. The slowest growth came from network websites, whereas the fastest growth came from Licensing & Other. YoY, revenue growth from network websites has slowed down from 23% in 2010 to 18% in 2011. Eliminating the revenues accumulated from Motorola Mobility, the company has shown a mere 3% revenue growth from 1Q2012 to 2Q2012. The revenue growth from advertisements seems to be slowing down as well, with incremental growth between 2010 and 2011 being 6%, as compared to 15% between 2009 and 2010. Google has not been able to generate enough revenues from sources other than advertisements, which are also slowing down. Therefore, it should be a concern for investors that effective monetization from Google's Android is still elusive.

$ millions

2008

2009

2010

2011

CAGR

2012 Q1

2012 Q2

Google revenue

21,796

23,651

29,321

37,905

15%

10,645

10,964

% Change

9%

24%

29%

3%

Total Advertising

21,128

22,889

28,236

36,531

15%

10,225

10,525

% Change

8%

23%

29%

3%

Google websites

14,414

15,722

19,444

26,145

16%

7,312

7,542

% Change

9%

24%

34%

3%

Network websites

6,715

7,166

8,792

10,386

12%

2,913

2,983

% Change

7%

23%

18%

2%

Licensing & other

667

762

1,085

1,374

20%

420

439

% Change

14%

42%

27%

5%

Click to enlarge

**Does not include revenue from Subsidies

Bearish Thesis

The biggest concern for Google investors should be the lack of monetization from Android. As computing shifts to tablets and smartphones, apps are becoming increasingly important. These apps are taking users away from the Google search engine. The app takes the user directly to the desired location, bypassing Google altogether. Google used to direct people to their desired locations in the browser-based computing model. However, with the current Android application count beyond 500,000, it does not give users too many reasons to bypass Google search.

Bullish Thesis

Google continues to bring forth new products to enrich its ecosystem, case in point being Google Wallet. However, these new products have, thus far, shown limited ability to bring in more revenues. However, we believe that Google Glass and Google Shopping have the potential to instigate revenue growth. We are bullish on the prospects of Google Shopping. It has the ability to compete with Amazon (NASDAQ:AMZN) and Ebay (NASDAQ:EBAY). The service will start bringing in revenues from 4Q onwards, and it can well have a positive influence on revenue forecasts.

Conclusion

If we look at the current valuations, Google is expensive as compared to its competitors, but it is trading below its industry P/E average. We recommend investors hold the stock, because Google is correctly priced at present. Upcoming events, which could affect the stock price, include next month's earning release, and the launch of Microsoft 's Surface tablet.

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

Business relationship disclosure: The article has been written by Qineqt's Technology Analyst. Qineqt is not receiving compensation for it (other than from Seeking Alpha). Qineqt has no business relationship with any company whose stock is mentioned in this article.