Why Investor's Shouldn't Fear Buying Google

It’s easy for investors to take Google (NASDAQ: GOOG) for granted. The company seems to grow seamlessly while so many others flounder amid the pressure of constantly having to deal with the challenges of technological change or even just trying to stay ‘cool’. In my view Google does these things well, and in this article I want to discuss the five reasons why the market fears certain things about the stock.

Google Is Normal Company

The first two reasons relate to the fact that it refuses to play the game according to the ‘rules’ of the market. Firstly, Google does not give guidance and secondly, it does not appear to have any plans to pay a dividend.

In the short term world that we live in, companies that don’t give guidance are creating ever more variance around their earnings results.  In the cold light of rationality it is quite remarkable that companies can see their evaluations change by 5-10% overnight just because they missed a few contracts or booked a few deals early in the quarter. But that’s how it works folks. The fact that Google doesn’t give guidance can cause some investment managers or brokers to shy away from the stock because they do not want to explain short term losses to their investors. Private investors shouldn’t care because their focus should be on long term development.

As for the dividend issue, I previously discussed it at length in an article linked here. There are valid concerns here. After all why buy a stock that cannot really be taken over and doesn’t offer much prospect of seeing cash flows--however large--returned to shareholders?  My guess is that the company would get a re-rating if it paid a dividend, and I think in time it will do so.

Hard Core Worries

The next two concerns the market has are that Google’s history is as a software company yet it continues to invest in hardware. The first point is that  investing in hardware requires it to constantly stay ahead of the completion. The second is that many of these investments are outside its core activities.  I will deal with each point in turn.

Investors only have to look at Apple (NASDAQ: AAPL) in order to start to get worried. Despite the endless lauding of the Apple ecosystem, at the end of the day, Apple’s prospects are guided by its hardware. And fashions change. A year ago Apple was unstoppable and analysts were competing to see who could come up with the largest estimates for iPhone 5 sales. Subsequently enthusiasm seems to have waned as many have realized Android offers comparable functionality and apps. Furthermore as other manufacturers catch up with Apple, why are emerging market customers likely to pay a few hundred dollars extra for an iPhone?

Frankly I don’t think these sorts of concerns are as big for Google. The Motorola acquisition is intended to support Android and will allow it integrate technologies with its own Nexus line of phones, but I doubt they will reach the kind of market share that Apple has now. However that is not the point. What really matters to Google with mobile is to continue gaining share with Android, to retain its dominance over mobile search and generate mobile ad revenues.

It's a similar story with regards to its non-core activities. Things like Google Glass, Google Fiber and driver-less cars are media attention grabbers, but there is little evidence that Google is a company not being run as a profit maximizer. In other words, if Google Fiber isn’t seen as being profitable then it’s hard to see the company rolling out huge networks. With regards to Google Glass, its price tag (around $1,500?) is highly likely to mean that it won’t become a mass market item. Throw in the inevitable privacy issues and the likelihood of a significant amount of mugging and it’s hard to see it becoming a blockbuster product.None of these products are fundamental profit drivers for the company.

Managing the Mobile Transition

A lot of investors tend to compare Facebook (NASDAQ: FB) to Google in terms of the shift to mobile, but I think Google is likely to do much better. Investors need to remember that the pull of using Facebook is in its user generated content. Will that content and how people interact with it stay the same with mobile? Or is Facebook inevitably going to migrate towards being Twitter with pictures? The content might change to encourage less usage time while concomitantly Facebook is pressured to introduce ever more intrusive advertising. So while Facebook is doing fine with mobile now, it faces a lot of challenges in the future.

Here is how Google is doing:

Part of the move downward in cost per click is due to the migration towards mobile, but nevertheless revenues grew overall at nearly 23% in the last quarter and it recorded 20% growth in its relatively more mature (and highly smartphone penetrated) markets in the US and UK. In the rest of the World, revenue growth hit 27%. Google is managing the transition very well, and whether search and advertising is desktop or mobile based, Google dominates.

The Bottom Line

In conclusion, I think investors are often afraid of Google for the reasons expressed above, but the key point is that its core revenues continue to grow strongly, and its strategic development remains on track. Its non core activities shouldn’t detract from the attractiveness of the stock. 

Its dominance of search and advertising across multiple formats isn’t going away anytime soon, and given the mid-single digit free cash flow yield and mid-teens earnings growth prospects I think the consensus analyst target of $900 looks achievable. I think it will get there quicker if it starts paying a dividend though.