Here’s today’s menu:

• Introduction

• Stock information

• Company background

• Financial performance - the good, bad and ugly

• Stock price performance

• Valuation

Introduction

Have you Googled something this week? Probably.

If you look up the word “google" in the dictionary, it describes it as “search for information on the internet".

Its fair to say that your company is Extraordinary when the entire world uses it's name as a verb.

But what do the numbers say?

Stock information

Company background

The name Google was derived from the mathematical term “googol”, which is the number 1 followed by 100 zeros. The name was chosen because that is a large number and mirrored the company’s mission of organising the huge amount of information on the internet.

Officially, the company is called Alphabet but it used to be called Google. So we’re going to refer to it by its old name.

Alphabet is a collection of businesses, the largest of which is Google. Google has two segments:

1. Google Services - which facilitates advertising on Google search, YouTube and with partners.

2. Google Cloud - which provides subscriptions to use Google’s infrastructure and other cloud services.

Financial performance

Google has brilliant numbers. Here's how it compares to the S&P500 - better on every metric and therefore more expensive (i.e. lower FCF yield).

The good

Looking at the table below, revenue is growing at a healthy 8.7% per annum. Free cash flow is growing at an even healthier 20.1% per annum.

Return on capital employed (ROCE) has averaged 22% over the past 5-years. Our rule of thumb is that anything over 15% is good. So the returns here are very good.

Equity-to-assets averages about 70%, which means that Google has only 30% debt. This is means Google is conservatively financed. The less debt a company has, the less likely it is to go bankrupt if there is a problem. But a little debt is not a bad thing.

The bad

There is nothing bad in Google’s financial ratios.

Perhaps we could complain about the FCF yield being low. This means the stock is highly priced. If you look at the first table, you will see that the stock is on a FCF yield of 1.6%. But more about valuation later.

The ugly

As with all US-based tech companies, the stock-based compensation (SBC) is extremely high.

High SBC falls in the ugly category because the company is being given away bit-by-bit to staff. This is disadvantageous to shareholders because they own less and less of the company as it is given away. Here's how it works.

In order to retain talent, management pays staff (including themselves) with stock instead of with cash. Management tells the shareholders that it saves cash because payment with stock doesn’t cost anything. Shareholders think they are getting a great deal, but they aren’t.

To hide the dilution (i.e. the company being given away), management engages in share buybacks, which uses real cash (so much for free workers). These buybacks are advertised as the company investing in itself because it is doing really well, but actually buybacks help to mask dilution. Shares are being given away, but the company keeps buying them back in the stock market.

When stock prices are rising, as they have been doing for a decade in the USA, staff are given stock at a certain value. A few years later when the company is buying back stock in the market, the staff are able to sell their stock at a profit.

That means, the company is paying more cash to buy the stock back from staff than it would have paid as salary a few years earlier. SBC merely defers payment to staff from the day the stocks are given to the day they are bought back, a few years later.

Staff love it, but its not good for you as a shareholder.

Stock price performance

Google’s stock price performance has been stellar over the past decade. Here are the returns over time:

• 1-year: 37.9%

• 3-year: 5.3% per annum

• 5-year: 22.4% per annum

• 10-year: 20.01% per annum

By comparison:

• The Nasdaq 100 has grown at 17.9% per annum for 10 years.

• The S&P 500 has grown at 12.9% per annum for 10 years.

• The MSCI World Index has grown at 10.01% per annum for 10 years.

Google has outperformed all three indexes. Brilliant.

Google’s exceptional operating performance has been recognised by the stock market with commensurate stock price performance. That is what we like to see from an Extraordinary Company.

Valuation

From a discounted cash flow valuation perspective, Google is above our moderate valuation - which gives it a negative margin of safety.

Google has a price-to-earnings (P/E) ratio of 22.6. The Nasdaq has a P/E ratio of 45 and the S&P500 has a P/E ratio of 27.

Google looks like it is close to fair value based on a discounted cash flow valuation, but it looks cheaper than the market based on P/E ratios. However, before you conclude that it is a bargain, take note that the market P/E ratios are already very high.

Conclusion

Google is still an Extraordinary Company.

Our analysis of Google included its latest results (Q3 FY2024) and it appears that Google is on track for a good year.

Google is not yet in the Extraordinary Companies portfolio, but I think its a good candidate for the portfolio.

I would like to hear what you’re up to.

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