Analysts Debate: Is Google Still a Top Stock?

The Motley Fool has been making successful stock picks for many years, but we don't always agree on what a great stock looks like. That's what makes us "motley," and it's one of our core values. We can disagree respectfully, as we often do. Investors do better when they share their knowledge.

In that spirit, we three Fools have banded together to find the market's best and worst stocks, which we'll rate on The Motley Fool's CAPS system as outperformers or underperformers. We'll be accountable for every pick based on the sum of our knowledge and the balance of our decisions. Today, we'll be discussing Google (Nasdaq: GOOG), the forward-thinking search company that's so well known it's become a verb.

Google by the numbers
Here's a quick snapshot of the company's most important numbers:

Sources: Morningstar, corporate reports, and industry analyses.

Alex's take
When we talk about buying Google, the argument tends to swing in two directions: dominance today, or innovation tomorrow. The case for Google's present-day dominance is easy to see, but also rather easy to poke holes in, if you want to be a negative Nancy. Look at how reliant Google is on ad revenue! All those smartphones aren't padding its bottom line like Apple's (Nasdaq: AAPL) iPhones! Google+ is a virtual graveyard and everyone's just using Facebook (Nasdaq: FB) instead!

Travis has pointed out in other articles that Google's greatest innovation was relevant search advertising, and it hasn't produced any significant new revenue streams since. That may be true, but this argument underlines the difficulty any company has turning great ideas into lots of money. Apple's had three major new innovations that have driven its growth into the world's biggest tech company, and all of them are functional extensions of an earlier innovation. The iPhone is a much more useful iPod, which built on the work of earlier MP3 players. The iPad is essentially a bigger iPhone. All of them extended Apple's ecosystem and made future Apple purchases easier to justify. Gmail, Chrome, YouTube, Android, and pretty much everything else Google designs have likewise all been part of a wide-ranging effort to functionally extend its advertising-driven ecosystem.

Let's also remember that it's not easy to make online advertising relevant. Facebook might claim that "sponsored stories" are successful because they're relevant to the social interactions of its users, but that's debatable -- the most frequent ads I see on Facebook promote politicians I won't vote for, resources for jobs I don't have, and products others have bought that I don't want. An ad is only as good as its relevance and accuracy, and as the de facto gatekeeper to Internet knowledge for a great deal of the world's population, Google has more tools than anyone else to make its ads relevant and accurate. How important is relevance? Google generates almost 10 times Facebook's revenue per user.

Ads work today, but what happens tomorrow?

Let's start with wearable augmented-reality computing, which Google is helping shepherd to market under the Project Glass moniker. Not only does Google seem to be learning a number of lessons in product design and marketing from Apple in its public rollout of this device, but it's also in the best position to capitalize from long-term public adoption. The hardware may turn a profit for a few years while Google has first-mover advantage, but nothing lasts forever. Who can make the best use of commoditized hardware that follows every step you take? The world's biggest advertising company, of course.

This is a very long-term view, as Project Glass headsets probably won't be available to consumers until 2014. That gives Google engineers and product guys two more years to play, test, promote, and perfect a device that has bigger implications for human-computer interactions than did mobile phones. Past that, there's self-driving car technology to build or license, which would be similarly transformative. These two technologies alone are bigger and bolder than anything in Apple's known bag of tricks and would extend the Google ecosystem in ways most companies can only dream of. For dominance today and the anticipation of tomorrow, I'm giving Google the big thumbs-up.

Sean's take
Google? What's that? Oh yeah, only a monster in the advertising space that has completely crushed both Microsoft's (Nasdaq: MSFT) Bing and Yahoo!'s (Nasdaq: YHOO) search engines into tiny bits. Five years ago, Google controlled 54% of all search-engine market share, and Yahoo! and Microsoft clocked in at 20% and 13%, respectively. Now, Google's 66% market share is more than double Yahoo! and Microsoft combined.

Another factor that makes Google great is the intangibles. Google's employees are happy and motivated and treated like kings. They have 25 free cafes, traveler's insurance, on-site medical care, and plenty of other perks. It's no surprise that Google hired a company-record 8,000 employees last year.

Still, I have notable qualms with Google that don't have me anywhere near as bullish as Alex. To begin with, while Google does command more than half of the mobile-ad market, no one is doing a particularly good job of capitalizing on mobile users -- Facebook, Google, nobody! It wouldn't be completely out of the question for another company to swoop in and steal mobile-based market share from Google. It'd also be wise to stop valuing Google as if it's completely dominating mobile ads, because mobile makes up just a fraction of total ad revenue at the moment -- most of its revenue is from search and PC-based ads.

Another issue I have with Google is its shelling out of $12.5 billion to purchase Motorola Mobility. Yes, the purchase netted Google a lucrative patent portfolio, but what's the reasoning behind the purchase? Google hasn't exactly been very forthcoming with its intentions, and until it is, it seems like a reach of a purchase that signals Google's lack of clarity for new avenues of growth.

Finally, Google's cost per click has been on a precipitous three-quarter decline. Year-over-year, Google's CPC dipped 16% in its most recent quarter, signaling the shift to mobile-based platforms.

As for my call, I currently have an underperform call on Google in my personal CAPS portfolio -- but on a fairly short-term basis. If the company can execute on its mobile expansion and identify how it plans to use what it gained from Motorola Mobility, I'd be willing to change my tune. As for now, it's a thumbs-down at any price north of $600.

Travis' take
As Alex pointed out, I'm skeptical of Google's ability to turn inventions into innovations, which is really what a business is all about. Project Glass is incredibly cool, and so is the self-driving car. There are undoubtedly a number of other cool projects in the works -- but if I'm going to give Google an outperform call, I won't do it because I look at these potential innovations as a call option for Google, providing upside with very limited downside.

So evaluating Google's current business is what I will focus on. As both Alex and Sean have pointed out, Google has a dominant position in the search and advertising market because of its ability to target ads better than anyone else. The search business also has the advantage of being consumers' first choice for finding something, invariably making it easier to charge advertisers for placement. I also don't see Yahoo! as much of a competitor in its current form, and Microsoft never seems to be able to capture a significant amount of search, no matter how many times Rob Dyrdek says he's "Binging" things.

This search dominance has led to strong revenue growth for Google since its inception, and growth is accelerating. Over the past year, Google grew at 29.3%, up from a five-year average of 21.5%. Earnings growth hasn't been quite as steady and has been flattening out in the past four quarters, but Google is still very profitable.

On a trailing basis, the stock trades at just over 20 times earnings. That's a great price for a company growing this quickly. Analysts are expecting that growth to continue, predicting $49.43 per share in earnings next year. On the balance sheet, Google has $43.1 billion in cash and short-term investments, offset by just $6.2 billion in debt. That means more than 15% of the company's market cap is in net cash, a strong value proposition.

With the value in the stock today, expected growth in its core business, and the potential for future growth if any of its products under development take off, I think Google will outperform the market over the next few years. I understand Sean's desire for a better price, but I'm willing to take the jump and swing the group to an outperform call.

The final call
Despite Sean's short-term bearishness, we're going to put our CAPS score where the majority of our mouths are by placing an outperform CAPScall on our collective TMFYoungGuns CAPS portfolio. After 16 total picks, we're beating the market by nearly 100 points, and we hope Google's long-term growth can offer us the same success as our previous calls on Facebook and Apple.

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