Google Proves Itself, But Is It Still a Buy?

Google (NASDAQ: GOOGL  ) , similar to Amazon and Apple (NASDAQ: AAPL  ) before it, has been a secular growth story to remember. Founded by Larry Page and Sergey Brin on Sept. 4, 1998, the company has become the world's search giant, the provider of many services that most Internet-connected users use daily, and is even a major smartphone vendor via its acquisition of Motorola Mobility. Google is a tech powerhouse, but after topping $1,000 per share following its earnings beat, is it a buy?

The core business is great
Google's third quarter was stellar, showing 12% year-over-year top-line growth and $2.97 billion in net income -- up a staggering 36% year over year. But the underlying business trends are what were really exciting. In particular, Google-owned sites generated a cool $9.39 billion in revenue, which was a staggering 22% increase over the prior period a year ago. Google's partner sites, on the other hand, generated only $3.15 billion in revenue -- a less than 1% increase year over year. While cost per click was down 8% year over year, the actual number of clicks was up 26% year over year -- an excellent result by all measures.

How about Motorola?
The Motorola Mobility division turned in revenues of $1.18 billion -- down rather substantially from last year's $1.78 billion. Keep in mind that Google's Android efforts are still a wild success as the proliferation of the platform across the world's phones and tablets has directly fed into Google's core business. However, with the Motorola division posting about $1 billion in annualized losses, some investors are still a bit skeptical of whether the acquisition was really worth it.

Management has repeatedly pointed out that the Motorola acquisition isn't necessarily about generating meaningful revenue and profit growth in the near term. It's much more a long-term strategic play. Now, it's not hard to envision a world in which Google's Motorola is one of the leading smartphone vendors, going head-to-head with the likes of Apple and Samsung (NASDAQOTH: SSNLF  ) . While playing this game is a tough one, Google's brand equity is enormous -- according to Interbrand, Google's the second most valuable brand -- and given the broad user acceptance of the Android operating system, it shouldn't be too painful for Google to get Motorola back in the game.

That being said, it's tough to deny the structural advantages in providing hardware that Samsung and Apple have. Samsung has a great cost structure, thanks to both scale and the in-sourcing of most critical components, so it can attack every segment of the smartphone market profitably. Apple owns the high end, thanks to a superb synergy of hardware, software, and brand equity. Time will tell, however, but betting against Google hasn't generally been a winning proposition. 

How's the valuation?
For growth stories like Google, it's always tough to pin a valuation on it. There are a lot of intangibles that go into the worth of the company, and there's always a very real element of uncertainty as to just what new growth initiatives the company will put in place over time. Who knows how well Google Glass will sell? What will Motorola Mobility do for the top and bottom lines once the products are revamped? Who could have known that when Google bought a tiny start-up called Android that it would become the phenomenon that it has?

That being said, it's not unreasonable to look for a 10-year, 15% compound annual growth rate in free cash flow, and then long-term growth of 5%, which would suggest a fair value of $1,081 per share today -- that's factoring in tangible book value of $183 per share. So, shares don't look meaningfully undervalued today. However, there's a lot of uncertainty here. Bumping up the 10-year CAGR to 16% gives a fair value of $1,142, and bumping it up yet another point yields a fair value of $1,210.

Of course, there's no way for investors to know now what that future CAGR is going to look like, so the market value is really going to depend on what investors collectively model as a realistic growth target based on today's information. Sentiment is very good around the stock, though, so it's likely that investors will give Google the benefit of the doubt.

Foolish bottom line
Google is a great, innovative company, and the shares could have anywhere from 8%-20% upside based on a discounted cash flow model with fairly reasonable assumptions. That being said, Google is a company that has, time and again, delivered and innovated in ways that no other company has. Buying into Google a little too high or early isn't the worst thing you could do to your portfolio as it'd most likely just be a matter of time before you're in the green once again. Just ask most Google investors. 

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