Google: Wait For A Pullback To $550

| About: Alphabet, Inc. (GOOG)
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Through diversification and smart allocation of company resources, Google's (NASDAQ:GOOG) management team was able to turn a nice search engine into an almost $200 billion company. But how does it stack up in the ever evolving information and communication realm, and where will it go from here?

The world's biggest advertising company doesn't actually design anything

Remember the power suits and short skirts worn by the cast members of Melrose Place on their way to an important advertising meeting? They wracked their brains for new, hip ideas about product placement, and carried large portfolios in black leather cases under their arms to impress potential clients.

While you are not likely to find any Heather Locklears on the staff of Google, the company made about $35 billion in advertising revenues last year, and it did not design a thing for its clients.

AdWords, AdSense, Google Display, DoubleClick. These are some of the branded names of the various advertising streams from which Google makes virtually all of its money. In the first quarter of 2012, 97% of its revenue was classified as Advertising. Even YouTube, which Google purchased in 2006, has evolved from the home of videos showcasing cats juggling balls of yarn with their feet, into largely an advertising portal, a site where small businesses can identify themselves to customers worldwide.

If you're a company with a web presence and you want your website to standout, it's been imperative that you use Google's AdWords or AdSense. These programs target popular key words used by internet searchers, and, if you pay for AdWords or AdSense, your website will appear higher on the list of Google search results. But is Google losing some of its advertising steam? After falling 8% in the fourth quarter of 2011, Google's revenue per click fell by another 12% in the first quarter of 2012. This downward pricing pressure, however, was offset by a 39% increase in the number of paid clicks during the first quarter. As a result, net revenue still trended higher.

But what if Google's market share in the search engine space were to fall? Obviously, this would have a crushing impact on Google's ability to raise advertising revenue. Bing, the relatively new search engine of Microsoft (NASDAQ:MSFT), reportedly owned 15.2% of the search engine traffic in the first three months of 2012. In the first three months of 2011, Bing accounted for about 13.9% of the U.S. search share. Losing 1.3% in a year may not seem like a huge blow to Google, but if the trend continues, I believe that Bing could represent the first real competition to Google in years.

Beyond the pay-per-click stuff

Like any well-run company, Google is diversifying itself beyond its substantial advertising streams. One of the hottest phrases in the technology industry these days is "cloud" computing and storage. Branded as 'Google Drive', the company has recently announced its foray into the cloud storage service, offering its users 5 gigabytes of free storage and additional storage for an extra cost. This puts Google in a head to head showdown with Apple (NASDAQ:AAPL) and its iCloud remote storage offering.

Google's Android operating system for mobile phones and tablets is another revenue stream for the company, but it has been slower to gain market share than the company was hoping for. Apple, its iPhones, and the iPhone's iOS operating system have put a hurt on not only competing producers of portable smart hardware like Samsung (not publicly traded in the U.S.) and Motorola Solutions (NYSE:MSI), but Google as well. Recent figures show that Apple controls nearly 60% of the smartphone market, versus only 36% one year ago, fueled in large part by the release of the iPhone 4S and its voice-activated assistant Siri. Siri, let's face it, makes for cooler commercials than anything Google Android-powered phones have to offer. And with the expected 2012 release of the iPhone 5, I believe Apple is poised to take even more of the smartphone market. Google is also still dealing with an ongoing lawsuit brought about Oracle (NYSE:ORCL). Oracle claims that Google's Android operating system infringes on Oracle's patented Java technology.

Google is now hoping to make an impact in the hardware market, recently announcing its intention to sell Samsung's Galaxy Nexus smartphone directly through its online store. The phone would be sold "unlocked", which means that the buyer can use it with a variety of service providers and not have to lock themselves into a long-term contract to be able to purchase the phone at a discount. The phone would come pre-installed with various Google applications. In theory, I don't believe it's a bad business plan at all. However, the 900 pound elephant in the room remains Apple and the iPhone. Unless consumers begin to move away from the iPhone, any of Google's efforts in the mobile hardware realm will be an uphill battle, at best.

Important legal stuff

As Microsoft shareholders from the 1990's can tell you, a company's legal considerations are not to be taken lightly. In addition to the lawsuit brought by Oracle, Google is currently involved in numerous other legal headaches, the largest of which involves a possible fine from the U.S. Federal Trade Commission (NASDAQ:FTC). The claim is that Google bypassed privacy settings on Apple's Safari browser when used by iPhones and iPads. Although the potential fines are not expected to be material to the company, it's a troubling pattern that may be worth watching. Google admitted to its role in the FTC case, and has since ceased the practice.


Bottom line: I'm neutral on Google. With a P/E ratio below 20 and a still impressive growth rate, I can't justly argue that the stock is expensive. But it certainly has some challenges ahead of it. If the stock were to dip below $550, on no substantial news, I would be a selective buyer. Otherwise, I'd turn my attention to other investments.

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