Is Google a buy?

Wednesday, 31 March 2010 22:39 Last Updated on Thursday, 01 April 2010 03:16 Written by James Van de Voorde

Google shares closed today at $567.12, down approximately 10% from its 52-week high of $629.51.  Much of the decline in the stock has resulted from recent news that the company has decided to pull out of the Chinese market, rather than cave to Chinese demands that Google censor its searech results.  While China currently represents only 2% of Google's sales, the Chinese market represents an enormous source of potential growth for Google.  Any rift with China may have longer term implications and the stock has taken a breather as a result.

So, is Google a buy?  Before answering this question, I must admit that I have been wrong about the direction of Google's stock price since the company went public.  I did not anticipate the dramatic way the company has almost single-handedly changed the advertising business and, to this day, remain skeptical that an Internet advertising firm is worth a substantial premium. 

On the positive side, Google boasts a pristine balance sheet with no debt and $25 billion cash on hand.  And it's Google brand has become synanamous with search in the same way Kleenex is ubiquitous for tissue.  Google's growth in the last decade is exemplary, but I fear it will be very difficult to replicate this growth going forward.  

90% of Google revenues come from search.  And for all the hocus-pocus algorithms that run behind the scenes, search essentially equals advertising, plain and simple.  People use Google and Google rings the cash register when the user clicks through on the search results, with advertising customers paying more for the prime locations on the search results page.  Growth overseas for this business seems promising, but less so if China is removed from the picture.  In the meantime, Google has 67% global market share and this business will remain their cash cow for the forseeable future, even if the growth rate slows.   

Google's software for service or "Google apps" business and mobile operating software and Android phones make up the balance of revenues.  In these areas, Google's competetion includes Apple, Microsoft and Nokia.  Indeed, Apple's iPhone revolutionized the use of "apps" which happen to bypass the need to access Google's search tool.  Apple and Google are likley to be at each other's throats for a very long time.  

Google currenlty trades at 21 times 2010 earnings and 18 times 2011 earnings that are expected to grow 15%.  Not wildly overpriced and not a bargain either.  With Google fighting battles against China and Apple, I can't help but think that future growth will be challenged.  If I owned Google, I would have to seriously consider selling at least a portion of my stake and locking in the profits for what has been an impressive run.