Google: Clicks and Moonshots

07/06/2015 7:00 am EST

Focus: STOCKS

Patrick McKeough

Editor, Successful Investor

Investors are concerned that the shift toward mobile devices is slowing growth for online advertising; developers have also launched new software that blocks online ads, which adds further uncertainty, asserts Patrick McKeough, editor of TSI Network.

As a result of these concerns, Google (GOOG; GOOGL) has moved sideways in the past year. The company, which controls about two-thirds of the global Internet search market, gets 90% of its revenue by selling advertising on its Web sites.

Advertisers pay lower rates for mobile ads because they’re harder to see on these devices’ smaller screens than on desktops and laptops. As well, people are more likely to buy goods or book vacations on a desktop computer rather than a mobile device.

Despite concerns, we feel the company’s new plan to promote mobile Web sites in its search results will spur its mobile ad revenue. That should give it an advantage over other online ad sellers.

Google has adjusted is search algorithms to make mobile-friendly Web sites rank higher than regular sites. That should encourage businesses to make their Web sites work better on smartphones.

This new approach also makes it easier for mobile users to access an advertiser’s app instead of the regular Web site. In addition, the company recently launched its own wireless service, called Google Fi.

Unlike regular plans, Google Fi uses free Wi-Fi networks whenever possible. It will be much cheaper than most cell phone plans and will refund the cost of unused data each month. Google also plans to launch the service in over 120 countries.

To support its initiatives, Google spent $2.75 billion (or a high 16.0% of its revenue) on research in the latest quarter.

Some of this spending goes to special projects that Google calls Moonshots. Many of these initiatives will fail, but some could become significant sources of future growth.

Perhaps the best-known one is the firm's self-driving car. Google will not build the cars, but will instead license the system to carmakers. Google can easily afford to keep investing in speculative products.

Meanwhile, the stock could rise sharply if Google began paying a dividend or announces a big share buyback plan. That would increase its appeal among big institutional investors, like pension funds, and spur the shares.

In the first quarter of 2015, it generated free cash flow of $3.7 billion. It holds cash of $65.4 billion, or $95.90 a share, and its long-term debt is just $3.2 billion.

The class C non-voting stock trades at 21.3 times the $25.30 a share that Google will probably earn in 2015. That’s a reasonable multiple in light of its high research costs and growth prospects.

Shareholders could keep holding their class A stock, but we recommend the cheaper class C shares for new buying.

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