Introduction:Â I use Google (GOOG, Financial) every day while online. This wonderful company makes excellent products and the ones that are the most beneficial to me are search, gmail, drive, chrome, maps, YouTube and images. In fact, the draft of this article was written in a drive document. Despite all these excellent products as well as many others not mentioned here, its core focus has always been connecting people to information with its search engine. Its search engine is dominant in the U.S. and other parts of the world. Looking at our flopturnriver.com site, almost all of its organic traffic is from Google. No other search engine amounts to more than 5% of the site’s traffic.
I accumulated a big position mainly in late 2010 and late 2011. The company has done well since that time, but I have concerns that were not as much of a factor a few years ago.
Takeaways:
This is a wonderful company with a unique history.
Stock-based compensation is relatively high now compared to 2010.
Facebook-type companies are more of a threat than they were in the past.
History
There are many factors that brought me to this investment a few years ago. Google is a special company and its history is inspiring. Getting many things right over the years, it is now one of the most valuable brands in the world.
It is ironic that the greatest search engine in the U.S. has a name that originates from a word being misspelled:
"He [Larry Page] said, 'How about we try Google?' He liked it shorter. I typed in G-o-o-g-l-e and misspelled it on my workstation, and that was available. Larry found that acceptable, and he registered it later that evening and wrote it on the whiteboard: Google.com. It had a wild Internet ring to it, like Yahoo or Amazon. And I came in the next morning and Tamara had written a note saying, 'You misspelled it. It is supposed to be G-o-o-g-o-l.' Of course that was already taken."
[The Google Story by David A. Vise pg 39]
Google's search engine tool has always been powerful such that it doesn't need a fancy design:
Tinkering one day with a graphics program called GIMP, Sergey created a color rendering of the Google letters with an exclamation point at the end, mimicking Yahoo! He seemed quite proud of the new logo, which was composed of kindergarten-style block letters in primary colors. But it wasn't the look that meant the most to him. He was pleased that he had been able to teach himself how to use GIMP, free software that was tricky to employ.
[The Google Story by David A. Vise pg 43]
The 2004 IPO Letter quotes Warren Buffett (Trades, Portfolio) about lumpy earnings being acceptable:
As a private company, we have concentrated on the long term, and this has served us well. As a public company, we will do the same. In our opinion, outside pressures too often tempt companies to sacrifice long term opportunities to meet quarterly market expectations. Sometimes this pressure has caused companies to manipulate financial results in order to "make their quarter." In Warren Buffett (Trades, Portfolio)'s words, "We won't 'smooth' quarterly or annual results: If earnings figures are lumpy when they reach headquarters, they will be lumpy when they reach you."
The IPO letter emphasizes that the company is in business for the long haul:
Don't be evil. We believe strongly that in the long term, we will be better served-as shareholders and in all other ways-by a company that does good things for the world even if we forgo some short term gains. This is an important aspect of our culture and is broadly shared within the company.
Stock Based Compensation
Some investors say large amounts of stock based compensation shouldn’t be worrisome because they are now expensed (in 2004 the FASB announced that share based compensation must be recognized in financial statements as an expense). As companies mature my personal preference is for them to keep stock based compensation under control.
Stock based compensation has been growing faster than net income over the last three years and this concerns me. I liked the fact that stock based compensation was only 16% as much as net income in 2010. In 2011 it rose to be 20% but it was still less than today’s level which is 26%. The graph below shows stock based compensation compared to net income for 2008 to 2013:
Sources: 2010 10-K and 2013 10-K
Again, I liked the fact that stock based compensation was relatively flat compared to net income between 2008 and 2010. This has not been the case between 2010 and 2013.
Facebook (FB)
Nothing today in search is as good as Google’s algorithm but it doesn’t do as much as it could with social signals. Google plus is not the same thing as Facebook — they are both social but the type of data and signals coming from the two platforms are different.
Facebook is a threat — it has a great deal of social data and could build a powerful search engine some day. However, there are limitations with social data. For example, how would Facebook figure out which doctors are more authoritative than others? Some might have more Facebook friends because they are nice, not because they know more about medicine.
Closing Thoughts
The level of stock based compensation is higher than I would like, but it isn’t high enough to make me sell my position in this wonderful company. Facebook is becoming more of a threat, but I do not believe all searches can be solved using social data at this time.
Disclosure
I am long GOOG. Any material in this article should not be relied on as a formal investment recommendation.
