gjangal's  Instablog

To say that GOOG is a dominant player in internet search would be an understatement. The search giant has cornered 65% of the internet search market over the last couple of years and it has increased its lead over its rivals MSFT, YHOOand AOL. Users keep coming back to the site as it provides them results with more relevance and precision to what they are looking for makes it a wonderful product

Revenue, Market Size:

GOOG derives 96% of its revenue from the text and display ads using its Adwords platform. The company is still in a growth phase. Consider this

I. GOOG reaches only 47% of all internet users which I believe there is still room to grow.

II. World internet penetration is around 35% with Asia and Africa's search market providing room for growth

Growth History and Potential:

GOOG has been growing its

I. Revenues at average annual pace of 24% over the last 3 years.

II. Operating margins are around 30%, 35% , 35% and 25% for the past 4 years.

III. Book value is growing at an average annual rate of 35%

IV. Generates around 14B in operating cash every year and growing

V. Cash on the balance sheet is 42B$

There is still some room to grow considering the level of internet penetration and average analyst estimates on Yahoo predict 21% revenue growth for the next 2 years with EPS estimates of 43$ per share for 2012 and 50$ per share for 2013. I would like to mention a couple of GOOG's parts that are interesting, although not from a valuation point of view

Smart phone market:

Android and IOS devices are resulting in more searches over the phone and it's a growing market for GOOG, However it comes at a cost of cannibalizing its desktop search. There are 5.7 billion active cellular connections. I believe a significant part of those users are going to be smartphone users. You may not own a desktop but you just might own a smart phone. The company is well positioned to serve ads there using its Admob platform on both Android and IOs.

YouTube:

The company does not provide detailed information about revenue from YouTube, which is the 3rd most visited site in the world. It does display ads on some of its user generated content.

Google Plus:

Efforts to beat Facebook seems to go nowhere at the moment. Although the company claims around 90 million users, time spent by those users on the site is negligible when compared to Facebook. Features like Hangout and Circles make it worth a try.

Motorola:

Motorola acquisition seems to be an effort to try to make better Device/OS coupling and also a shot at the tablet market. How they will fare at that is a question of time.

Valuation:

For a business that is projected to grow at 21% for the next 2 years, it is trading at a PE of 17, which is very cheap. If you assume 21% growth for the next two years and then assuming it might taper, DCF and Graham style calculations give you a value of around $750 at least based on your assumptions of near term growth and terminal growth.

Predicting growth is a hard thing to do as it's in the future, but if you make reasonable assumptions about it and are willing to reconsider your decision based on how those growth prospects pan out. I believe $612 for GOOG is a cheap price to pay.

Disclosure: I am long GOOG, MA, SBUX.