Google Is Worth Every Penny

I'm a huge fan of Google (Nasdaq: GOOG  ) . Though I've had my reservations in the past about the company's buoyant share price, this week I find myself defending the world's most valuable dot-com entity, after my fellow Fool Stephen Ellis claims that Google is worth less than its present 12-figure market cap.

I believe that Google's moat is wider than some think. I also feel that too many investors see a high share price and make the assumption that Google is insanely overvalued.

Let's dive right in.

"At 17 times sales and a P/E of 74, I think its stock is priced to perfection -- and then some," Stephen argues.

Let's expand on that for a bit. Stephen is referring to last year's results. That's fine in the sense that it's the most current concrete production that we can base those metrics on, but let's look at where analysts are standing. Based on their projections and Google's $109 billion market cap last week, Google is trading at just 41 times this year's earnings and 30 times next year's. I should point out how Google has blown past Wall Street's targets in four of the past five quarters.

Now, snapping up shares of Google today at a little more than 30 times next year's profitability may not scream "cheap," but it's considerably less than what other dot-com bellwethers, such as Yahoo! (Nasdaq: YHOO  ) and Amazon (Nasdaq: AMZN  ) , are fetching. And, yes, Google is also growing more quickly and working on fatter margins.

Thankfully, Stephen doesn't end his assessment there. He does the right thing by taking his analysis one step further and breaking down the various scenarios that may weaken Google in the future.

The perils of click fraud
Yes, click fraud is a problem, but the concerns are mostly overblown. Google has been pretty good in snagging errant third-party publishers and refunding advertisers. It has even gotten its legal department involved to set an example. In cases where rival sponsors may try to click-fraud a competitor's ad budget dry, Google is also pretty good in picking up on the irregular activity.

Click fraud may seem like an integrity killer, but it all adds up at the end of the day. Advertisers know that paying pennies -- or a bit more -- per lead is a good deal, even with the virtual pilfering that gets past Google. This will probably be a bigger problem for Google's competition, if anything, since the Big G has already invested years in perfecting its policing efforts.

Canaries in a coal mine?
Stephen is right that companies such as Blue Nile (Nasdaq: NILE  ) have complained that online advertising rates are inching prohibitively higher, but I wouldn't go as far to say that "the rising cost of keywords is another dangerous trend for Google." Sorry, Stephen, that's a gripe that smells of Yogi Berra's famous quote: "Nobody goes there; it's too crowded." Companies like Blue Nile are whining because they no longer have the sandbox to themselves. More traditional and local advertisers are discovering the joys of tracking their ad campaigns, and landing that perfectly targeted audience is still dirt cheap. If e-commerce vets think that the bidding prices for keywords are irrational now, just wait until even more advertisers hop on.

The costs of content
Stephen argues that content isn't cheap. However, the company's organic revenue growth has been growing more rapidly than its AdSense network of third-party sites over the past few quarters. That's significant, because Google's margins are substantially higher on its own turf. In terms of Google's role as a content aggregator, comScore has Google's market share of the search market growing at the expense of fading competitors such as Yahoo! and Microsoft's (Nasdaq: MSFT  ) MSN.com. The way website operators watch for every update of Google's page-ranking algorithm tells me that whatever Google wants from them, it will get.

Don't be evil (most of the time)
Privacy issues and the geopolitical culture clash of international expansion have earned Google some unsavory headlines recently. However, if the alternative was martyrdom -- being entirely barred from the Chinese market, for example -- I'm not so sure that investors would be willing to live with the high cost of pride.

Expand first, make money later
Stephen argues that Google seems "committed to expanding into as many markets as possible, as quickly as possible, and working out how to monetize those markets later." I'd argue that this strategy worked out well for a company like Amazon or Netflix (Nasdaq: NFLX  ) , and that Google's sky-high margins haven't been any worse for wear despite the company's expansion into new areas.

In fact, since I don't see that Google has followed Yahoo! into online dating, auctions, or job listings -- or Microsoft into video games -- I think Google may be one of the more focused players in this space. Google is only doing what others would do if they commanded the same expanse of virtual real estate. These side projects haven't taken away from the company's commitment -- its employees still devote 70% of their time to improving the company's core search product. If Google is going to grow beyond the reach of traditional advertising powerhouses, logical expansion into the hearts and desktops of a growing online audience is the only way to go.

Blue Nile has been recommended toRule BreakersandMotley Fool Hidden Gemsnewsletter subscribers. Netflix and Amazon.com have been winning picks forStock Advisorreaders. Microsoft is anInside Valuepick. Try out your favorite investing newsletterfree for 30 days.

Longtime Fool contributor Rick Munarriz is a huge fan of Google, and it would be his homepage if not for Fool.com. He does not own shares in any of the companies in this story.The Fool has a disclosure policy. He is also part of theRule Breakersnewsletter research team, seeking out tomorrow's ultimate growth stocks a day early.


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