Google (NASDAQ:GOOG) (NASDAQ:GOOGL) is one of the biggest positions in my portfolio. The stock is up by more than 130% over the last five years, so performance has been quite strong over the long term. On the other hand, Google is down by 7% in the last 12 months, substantially lagging the Nasdaq index and its gain of 12% over the same period.
This short-term underperformance is no big reason for concern, since I make my investment decisions with a long-term focus. Still, this may be a good time to revisit my investment thesis on Google, so here are the three main reasons why I believe Google is a strong candidate to hold over years to come.
1. Unquestionable quality
Google is one of the most valuable brands in the world -- the name is so powerful that many consumers use the term "Googling" for information as a synonym for online search. Only the most dominant brands on the planet enjoy this kind of presence, and Google has a gargantuan market share of more than 90% in the global search market according to data from StatCounter.
In addition, Google owns many of the most popular platforms, services, and applications around. According to management, there are more than 1 billion people on Android devices around the planet, and the company paid more than $7 billion to Android developers over the last 12 months. YouTube is the most popular video service on all screens, with hundreds of millions of hours watched on the platform on a daily basis. Besides, applications such as Gmail, Chrome, and Maps are among the most popular and ubiquitous, both in desktop and mobile.
The numbers look quite solid too: Constant-currency revenues grew 17% during the last quarter, and the business generates a big operating margin in the neighborhood of 26% of sales. Google has a pristine balance sheet with more cash and liquid investments than debt, so financial soundness is unquestionable.
2. Growth potential
According to estimates from PricewaterhouseCoopers, the U.S. online advertising industry produced $49.45 billion in revenue during 2014, and this figure is expected to grow to $83.89 billion by 2019. On a worldwide basis, digital ad spending is expected to increase from $145 billion in 2014 to a massive $253 billion by 2018. Even if Google will face increased competitive pressure from smaller players in online advertising, the company will most likely remain one of the main beneficiaries from a booming online advertising industry over the years ahead.
Also, the company is investing in many aggressively innovative technologies such as self-driving cars, outer space exploration, alternative energy sources, and breakthrough medical advancements, among several others. Chances are many of these projects will have little or no economic value, but some of them could offer amazing possibilities over the years.
The good news is that these initiatives are already reflected on the company's cost structure, and Google is still a remarkably profitable business in spite of the fact that these "moon shot" projects are producing practically no revenue at all. The way I see it, when being considered as a diversified group of futuristic technologies, these projects offer far more upside potential than downside risk for investors in Google.
3. Attractive valuation
Even the best companies can be bad investments if the price is too high. However, that's hardly the case when it comes to Google, as the online search giant trades at a conveniently attractive valuation.
Google carries a forward P/E ratio of 16 times earnings forecasts for 2016, roughly in line with the average company in the S&P 500 index. But Google can easily justify an above average valuation based on its rock-solid leadership in online advertising, profitable business model, and exciting growth prospects.
No company is immune to competitive risks, and Google operates in a very dynamic environment. Facebook (NASDAQ:FB) is making big inroads in online advertising, as the social network has exponentially increased revenues from less than $2 billion in 2010 to $12.5 billion in 2014. Facebook announced an explosive increase of 49% in constant currency sales during the last quarter, so growth is not slowing down at all.
Chances are Facebook and other relatively younger companies will keep outgrowing Google over the middle term, although from a much smaller revenue base. The main point is that competitive risk seems to be already accounted for in Google's current valuation. At these prices Google stock is offering a pretty attractive combination of potential return versus downside risk.