What's Wrong With Google's Stock?

 | Jun 15, 2015 | 5:00 PM EDT
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Since Google (GOOGL) did its two-for-one stock split last April, the shares are down more than 5%. The Nasdaq Composite is up nearly 20% over that same period. So what's wrong with Google's stock?

Tech money managers and investors have to choose which mega-cap growth stocks they're going to own. Every dollar allocated to Google equity is a dollar not allocated to Facebook (FB) Apple (AAPL) or maybe Netflix (NFLX). Let's do some comparative analysis on Google and Facebook to see what we can learn.

Google's search and Internet ad businesses are set to grow slowly, probably 5% to 10% per year steadily, and the company will continue to kick off billions of dollars of cash flow and subsidize its other ventures and businesses. Google has already pretty much perfected the monetization it is going to get out of its primary search and Internet ad businesses. I don't own Google because of its search and Internet ad businesses; I own Google for its other billion-user platforms that, like Facebook's own platforms, are barely getting started regarding how their revenue models work and how the platforms will be monetized. 

Facebook is very early in the game of monetizing its 1.4-billion-user base and could grow the amount of revenue generated per subscriber 10x. It also has the WhatsApp messenger app and the Instagram platform. Each has a billion users but neither has been monetized much. Revenue streams from advertising, sponsorships, payment transfers and who knows what else are still coming to Facebook, WhatsApp and Instagram. 

The market sees the potential of Facebook's billion-user platforms, and that's a small part of why Facebook is now valued upwards of a quarter of a trillion dollars. When I first started buying Facebook, when shares were in the $20s, I used to explain how cheap Facebook was compared to its earnings potential of just two to three years out because Facebook just needed to generate a few pennies per user per day:

So here's that math I talked about before and how Facebook FB gets to a $200B market cap. Their valuation right now is just under $70 billion. Last year's revenues were about $3 billion so that's 22x sales, let's say 20 for good measure. Facebook says they have 900M monthly active users (MAUs), a 33% jump from the years before. So let's say the prices/sale multiple holds over the next five years, that would mean Facebook would need $10 billion in revenue to get to a $200 billion market cap. But let's halve the multiple to 10x sales, so we're looking for $20 billion in sales. And let's say that explosive MAU growth slows by a third to 11% for the next five years, that would give Facebook 1.5 billion engaged users. Divide that $20 billion in revenue by the 1.5 and you get that at that depressed multiple of 10x sales, with anemic future user growth, if Facebook generates $13 in revenue per user per year, it's at a $200 billion market cap.

Here we are two or three years later and the company has 50% more users, is generating a few pennies per user per day and the stock has quadrupled from those levels, giving it market cap that's even bigger than the one I was looking for back then.

Frankly, Faceboook is still a bit cheap if you're willing to look out another three or four years and see that the company just needs to generate a few pennies of revenue per user per day in 2017 or so, and that would kick off billions of dollars in revenue per month. 

Google's Chrome, YouTube and Android apps each have at least one billion users too, and Gmail has nine hundred million users. Of the three, I rank them by value as follows:

  1. Android: This is going to be the dominant operating system for tens of billions of devices, the Internet of Things, wearables and so on. I expect that five or 10 years from now that Google will be generating a few pennies per day of revenue from, yes, advertisements, sponsorships, payment transactions and who knows what else.
  2. YouTube: There are only so many ways to sneak those annoying ads into the videos, and it appears YouTube's ability to grow revenue per user is nowhere near as excited as Facebook's roadmap. 
  3. Gmail: Already very monetized.
  4. Chrome: It helps Google understand and/or learn about its users, but perhaps not monetizable per se (remember Netscape?). Does Internet Explorer make any money for Microsoft (MSFT) or Safari for Apple (AAPL)?

Is Android going to create hundreds of billions of dollars for Google shareholders the way that Facebook's platform has for Facebook shareholders? That's not entirely clear yet, and that's why Google's stock is struggling to break out for the last couple of years. Facebook's worth $270 billion. I think it's safe to say that Google's old search/ads businesses (and the earnings they kick off) still make up the vast majority of Google's current market cap. If Google can create another couple of hundred billion dollars of value out of Android and/or YouTube in coming years, the stock will triple or more from these levels. If Google fails to grow Android into a sustainable dominant business kicking off huge cash, Google's probably going to remain stuck somewhere near current levels. 

I have owned Google, Apple and Facebook for years and I plan to own each of them for several years more. 

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