Every Thursday we bring you recommended U.S. stocks. These picks come from our newsletter on U.S. stock investing, Wall Street Stock Forecaster,or from our advisory for more aggressive investing, Stock Pickers Digest. This week, we explain why we continue to rate Google as one of our best tech stocks. (For our most recent report on another tech giant, Apple, click here).
Google’s shares have moved sideways in the past year, mainly because investors are concerned that the shift toward mobile devices is slowing growth at its online advertising business. Developers have also launched new software that blocks online ads, which adds further uncertainty.
However, we feel the company’s new plan to promote mobile websites in its search results will spur its mobile ad revenue. That should give it an advantage over other online ad sellers, like Facebook. To top it off, the stock could rise sharply if Google began paying a dividend or announced a big share buyback plan.
GOOGLE INC. (Nasdaq symbols GOOG [class C: nonvoting] and GOOGL [class A: one vote per share]; www.google.com) controls about two-thirds of the global Internet search market, mainly because its innovative technology helps users quickly find the information they’re seeking. The U.S. supplies 43% of the company’s revenue.
Google gets 90% of its revenue by selling advertising on its websites. It mainly does this through its AdWords program. Using AdWords, advertisers bid on certain search words or phrases. The company then charges advertisers when users click on their ads.
In addition to search, Google offers other free services and software, including Gmail (email), YouTube (videos), Google+ (social networking), Chrome (a web browser) and Android (mobile phone software). These services draw more users to Google’s sites, which lets it sell more ads and charge higher ad rates.
In the three months ended March 31, 2015, Google’s revenue rose 11.9%, to $17.3 billion from $15.4 billion. Overall earnings gained 5.4%, to $4.5 billion from $4.3 billion, while per-share earnings rose 4.8%, to $6.57 from $6.27.
The number of paid clicks on advertisers’ ads rose 13% in the latest quarter. That helped offset a 7% drop in the average cost advertisers paid per click, because more users are accessing the Internet with smartphones and tablet computers.
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.
In response, Google has adjusted is search algorithms to make mobile-friendly websites rank higher than regular sites. That should encourage businesses to make their websites work better on smartphones. This new approach also makes it easier for mobile users to access an advertiser’s app instead of the regular website.
In addition, the company recently launched its own wireless service, called Google Fi.
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Top tech stocks: Cheaper class C shares recommended for new buying
Unlike regular plans, Google Fi uses free Wi-Fi networks whenever possible. When Wi-Fi is unavailable, it will switch users to one of two existing cell networks, T-Mobile or Sprint, whichever is stronger at the customer’s location.
Google Fi will be much cheaper than most cellphone plans and will refund the cost of unused data each month. Google also plans to launch the service in over 120 countries.
Google Fi will likely be as successful as the company’s Google Fiber Internet and TV service, which is 30 times faster than competitors’ offerings. So far, the company has installed Google Fiber in eight U.S. cities and plans to expand to over 30 more in the next few years.
To support these initiatives, Google spent $2.75 billion (or a high 16.0% of its revenue) on research in the latest quarter. That’s up 29.5% from $2.1 billion (or 13.8%) a year earlier.
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 company’s self-driving car, which aims to reduce accidents caused by human error and speed up traffic flows. Google will not build the cars, but will instead licence the system to carmakers.
Google can easily afford to keep investing in speculative products. In the first quarter of 2015, it generated free cash flow (cash flow minus capital expenditures) 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.
Like Apple, Cisco and other big technology firms in the past few years, Google may soon decide to start paying a dividend or buy back some of its shares. That would increase its appeal among big institutional investors, like pension funds, and spur the shares.
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 should keep holding their class A stock, but we recommend the cheaper class C shares for new buying.
Recommendation in Wall Street Stock Forecaster: BUY.
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