Mention American search-and-online-advertising business Google (GOOG), and Android smartphones and futuristic glasses probably spring to mind well before the thought of a 'cheap stock' does. But the Internet giant's rapid growth and broad investment strategy means its shares could prove just that.
- Strong profit growth forecast
- Diversifed market presence
- Impressive cash generation
- Sale of Motorola to boost profits
- Hardware bets may shrink margins
- New products increase risk
- IC TIP RATING
- Tip style: GROWTH
- Risk rating: MEDIUM
- Timescale: LONG TERM
At first glance, Google's share price may look expensive - it is up about 50 per cent in the past year and stands at 21 times broker JPMorgan's EPS forecasts for 2014. However, strip out the substantial net cash pile and factor in the broker's average EPS growth forecasts for the next two years (see table), and the shares trade on a very attractive cash-adjusted price-to-earnings-growth (PEG) ratio of less than one, suggesting that Google shares do, indeed, represent a 'cheap' growth play. What's more, Google's track record inspires confidence and its cash generation is increasingly impressive, with operating cash flow coming in at over $5bn in each of the last two quarters.
The Google Growth Machine
US:GOOG | 5-yr CAGR | Forecast FY2014 growth | Forecast FY 2015 growth |
---|---|---|---|
Revenues | 22.4% | 19.8% | 17.7% |
Underlying EPS | 22.1% | 22.6% | 23.1% |
Source: S&P CapitalIQ and JP Morgan forecasts
We believe brokers' growth forecasts have a solid foundation. Google dominates its key internet-search-engine market and accounts for just over two-thirds of internet search activity in the US. In the final quarter of 2013, paid click growth, or the number of times internet users clicked on its ads, also jumped 31 per cent - the highest growth rate in five quarters. Importantly, Google's dominance means it should continue to reap the rewards of the digital advertising sector's growth and win market share - its share of digital ad revenues was just under 40 per cent last year, and is expected to rise to 40.8 per cent this year then 42.3 per cent in 2015, according to digital researcher eMarketer.
Google isn't a one-trick pony, either. It owns the Android operating system, used in over 80 per cent of smartphones shipped worldwide in the third quarter of last year, according to research firm IDC. That's good news, as getting cheap smartphones into as many hands as possible allows Google to drive traffic towards its core search and advertising businesses.
YouTube could also be a major contributor to future growth. The online video platform already boasts 1bn monthly users and the average time viewers spent watching videos though the site last year was up by more than 50 per cent. And if Google improves its live events and original content offerings, it could tap into TV advertising budgets and capture lucrative market share from streaming services Netflix and Amazon Prime.
GOOGLE (US:GOOG) | ||||
---|---|---|---|---|
ORD PRICE: | $1,177 | MARKET VALUE: | $395bn | |
TOUCH: | $1,174-1,176 | 12-MONTH HIGH: | $1,187 | $761 |
DIVIDEND YIELD: | nil | PE RATIO: | 18 | |
NET ASSET VALUE: | $257 | NET Cash: | $53.5bn |
Year to 31 Dec | Turnover ($bn) | Pre-tax profit ($bn) | Earnings per share ($)* | Dividend per share (¢) |
---|---|---|---|---|
2011 | 37.9 | 12.3 | 29.8 | nil |
2012 | 50.2 | 13.4 | 32.3 | nil |
2013 | 59.8 | 14.5 | 38.1 | nil |
2014* | 71.5 | 19.0 | 53.8 | nil |
2015* | 84.2 | 23.8 | 66.2 | nil |
% change | +18 | +25 | +23 | - |
Ex-div: na Payment: na Beta: 0.99 *JPMorgan forecasts, diluted EPS figures |
A cost-cutting angle has also recently emerged to enhance Google's earnings growth story. The company announced it is selling its loss-making Motorola Mobility handset business to Chinese computing company Lenovo. True, the $2.9bn price tag looks pretty paltry compared with the $12.5bn Google paid in 2011, but Google will retain most of Motorola's enormous patent portfolio and JPMorgan estimates the elimination of Motorola's losses could lift EPS by more than $2 (something not yet factored in to the figures quoted in our table). The sale should also improve Google's relationship with other Android smartphone manufacturers, to whom Google was previously both supplier and competitor.
Of course, there are risks to investing in Google. Its shift from the digital world into hardware businesses with limited revenues, such as it recent $3.2bn acquision of 'smart' thermostat-maker Nest, may depress its margins and increase capital expenses. The company has also spread its bets across numerous industries, and there are bound to be a few lame ducks. However, this portfolio of exciting technologies could also create significant value based on Google's past successes.