netrashetty
Netra Shetty
Google Inc. is an American multinational public corporation invested in Internet search, cloud computing, and advertising technologies. Google hosts and develops a number of Internet-based services and products,[6] and generates profit primarily from advertising through its AdWords program.[3][7] The company was founded by Larry Page and Sergey Brin, often dubbed the "Google Guys",[8][9][10] while the two were attending Stanford University as Ph.D. candidates. It was first incorporated as a privately held company on September 4, 1998, and its initial public offering followed on August 19, 2004. At that time Larry Page, Sergey Brin, and Eric Schmidt agreed to work together at Google for twenty years, until the year 2024.[11] The company's stated mission from the outset was "to organize the world's information and make it universally accessible and useful",[12] and the company's unofficial slogan – coined by Google engineer Paul Buchheit – is "Don't be evil".[13][14] In 2006, the company moved to their current headquarters in Mountain View, California.
Google runs over one million servers in data centers around the world,[15] and processes over one billion search requests[16] and about twenty-four petabytes of user-generated data every day.[17][18][19][20] Google's rapid growth since its incorporation has triggered a chain of products, acquisitions, and partnerships beyond the company's core web search engine. The company offers online productivity software, such as its Gmail email software, and social networking tools, including Orkut and, more recently, Google Buzz. Google's products extend to the desktop as well, with applications such as the web browser Google Chrome, the Picasa photo organization and editing software, and the Google Talk instant messaging application. Notably, Google leads the development of the Android mobile phone operating system, used on a number of phones such as the Nexus One and Motorola Droid. Alexa lists the main U.S.-focused google.com site as the Internet's most visited website, and numerous international Google sites (google.co.in, google.co.uk etc.) are in the top hundred, as are several other Google-owned sites such as YouTube, Blogger, and Orkut.[21] Google is also BrandZ's most powerful brand in the world.[22] The dominant market position of Google's services has led to criticism of the company over issues including privacy, copyright, and censorship
Our first analysis of Google begins with the Balance Sheet. The balance sheet is sometimes referred to as a financial snapshot, because it represents the business only at specific time periods.
First, it is essential to evaluate what the business is worth. This brings up what is known as the value problem: involving the conflicting issue between the book value and the market value. The book value of the company is simply the shareholder’s equity, which is found on the balance sheet. This is because the accounting equation, A=L+OE refers to the assets minus the claims against the assets to equal the book value of the company. However, this does not represent Google’s actual value. The market value of the company more accurately reflects the true worth of the corporation. There are two reasons for the discrepancy:
1. Financial statements are transaction based. The transaction figures are recorded when they occurred and entered into the balance sheet. The figures are never adjusted for the time value of money so there is very little relevance. Also, depreciation does not accurately reflect the true worth of assets.
2. Investors buy the stock for expectations of future earnings, not for the underlying value of investors. This is an important distinction, especially in a technology company like Google’s where investors rely so heavily on intangible assets, which are very difficult to assign an intrinsic value to.
The market value of Google was found to be $145.4 Billion. (See Appendix A-1). The market value is calculated by multiplying shares outstanding by the price per share. This is also referred to as market capitalization. Google’s market capitalization compares to $38.4 Billion for Yahoo, its closest competitor. This shows that Google has established an enormous market share, due to its strong core competencies, which will be mentioned later.
To compare the two, market value and book value, we use the Price to Book value ratio, which is found by dividing the company’s market capitalization by the book value of the equity. Google’s Price to Book ratio is 8.67 (See Appendix A-2). It is used to compare the stock’s market value to its book value. As would be expected, the market value of the stock is much greater than the book value. This is because of the intrinsic value of the intangible assets, such as intellectual property, which is not reflected in the financial statements.
Yahoo Google Microsoft
Price to Book 4.192 8.668 7.467
As can be seen by comparing it to the industry standard, the price to book is higher, indicating that the business is almost entirely based on intangibles.
Another important method to evaluate the market’s representation of value is known as the price to earnings ratio. This number compares its current market value per share to the earnings per share. Due to its continually high earnings, Google’s P/E ratio is 42.5 (See Appendix A-3). Price to earnings is at the industry average for other companies in the industry, those in the technology sector.
Yahoo Google Microsoft
Price to Earnings 56.1 42.5 22.0
According to Investopedia, “The P/E is sometimes referred to as the "multiple", because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings”. (Investopedia.com, 2007) Because a company in the technology sector has such a high level of intangible assets, it can be very difficult to evaluate. This is why as we mentioned earlier, the book value is irrelevant. Valuation is based more on expectations of future earnings. Having such a high P/E multiple means that Google needs to consistently hit the high expectations that investors set. As a result, it seems that there may exist more downside than upside with a company in this industry as seen during the tech crash of 2001.
To continue, it is important to see how liquid the business is. Having short-term liquidity will aid the company to meet its short-term obligations when the business is in financial distress. We can use the current ratio, or the quick ratio to measure this. The current ratio includes all current assets divided by all current liabilities. The quick ratio, or acid test, is the more conservative approach because it excludes inventory due to its low resale value. However, it turns out that the two ratios are the same because Google does not carry any inventory. By avoiding use inventory, Google is able to save substantial carrying costs (i.e. storing in warehouses). The quick ratio turns out to be 10.0 (See Appendix A-4, A-5), which is extremely liquid. Generally a ratio above 2.0 is considered positive. However, generally the ratio only has meaning when compared to others in its industry.
Yahoo Google Microsoft
Quick Ratio 2.561 9.995 2.118
Current Ratio 2.561 9.995 2.184
Google’s quick ratio is much higher than its competitors. Thus, it has very little difficulty meeting short-term obligations compared to its competitors.
Next, we analyzed how much working capital Google has. Working capital is used to measure both a company’s efficiency and its financial health (short term). Working capital is calculated by subtracting current liabilities from current assets. Google’s working capital is found to be $11,735,260,000(See Appendix A-6). By itself the figure is insignificant. The large working capital signifies that Google is not in danger of having trouble paying off current liabilities. For further meaning to the working capital figure, we compared it to previous years. This is because working capital provides insight into how efficient the operations are. If money is tied up in inventory or accounts receivable, the company lacks liquidity to pay off obligations.
Year Current Assets Current Liabilities Working Capital
2003 560.2 235.5 324.7
2004 2,693.50 340.4 2,353.10
2005 9,001.10 745.4 8,255.70
2006 13,039.80 1,304.60 11,735.20
The increase in working capital seems like a positive attribute of growth. However, it also can indicate that a company is not operating efficiently. This suggests further analysis into the collection of the company’s current assets (accounts receivable). In fact, its accounts receivable are among the worst in the industry with 35.96 days worth of outstanding sales. (See Appendix A-7). This verifies the null hypothesis that revenues are not being collected in an efficient manner.
Digging deeper, we looked at fixed asset turnover. It is an important measure of capital intensity, with a low turnover implying high intensity. The fixed asset turnover is found to be 4.43(See Appendix A-8). This number gives the investors an idea of how effectively management is using the assets. It is a measure of the productivity of a company’s fixed assets with respect to generating sales. By itself the number is irrelevant though. It must be compared to its competitors.
Yahoo Google Microsoft
Fixed Asset turnover 6.9 4.43 15.3
The above comparison suggests that Google has higher capital intensity than that of its competitors. Also, it suggests possible inefficiency of using its assets.
The total asset turnover is found by dividing sales by assets. It is found to be 0.57. (See Appendix A-9). This figure represents the amount of sales generated for every dollar’s worth of assets in the business. It measures Google’s efficiency in generating revenue with its assets. Generally it is inversely related to profit margin. The lower profit margin it has, the higher its asset turnover will be and vice versa. Sure enough, because Google has a low asset turnover, its profit margin is high. It is found to be .290 or 29%. More importantly, it increased from .239 in 2005. This signifies an asset intensive business. It is consistent with others in its industry (i.e. Yahoo).
Yahoo Google Microsoft
Total Asset Turnover 0.5581 0.5741 0.6363
Another important ratio for analysis is known as Return on Assets. This profitability ratio shows how much a company is earning on its total assets. Thus, it is an indicator of asset performance. Google’s ROA figure is calculated to be 0.1666. (See Appendix A-10). This means that the business earned 17 cents on every dollar tied up in the business from both creditors and owners. It increased from 14.3 cents last year. Thus, it appears to be more effectively using its assets.
Return On Assets Yahoo Google Microsoft
2004 9.15% 12.05% 8.66%
2005 17.51% 14.27% 17.30%
2006 6.53% 16.66% 18.10%
Another key profitability ratio is return on equity used for measuring the efficiency with which a business uses owners’ capital. It measures the percentage of return to owners on their investment (ROI). If investors are not being rewarded for their investment, they will no longer be motivated to invest. There are three levers for controlling ROE: profit margin, asset turnover, and the financial leverage. The Return on Equity was calculated to be 18.047% (See Appendix A-11), an increase of about 2.5% from the previous year. The discrepancy between ROA and ROE can be explained by Google’s small use of financial leverage.
Return On Equity Yahoo Google Microsoft
2004 11.8% 13.6% 10.9%
2005 22.1% 15.6% 25.5%
2006 8.2% 18.1% 31.4%
To continue, we analyzed debt more closely. Having debt can greatly restrict a company’s flexibility. However, Google has no long-term debt. This is because they are able to use entirely equity based financing. There is little inherent financial risk to the business because it has a very conservative capital structure. It does not rely on leverage.
While Google is still exhibiting substantial growth, it is beginning to reach maturity as indicated by its sole use of equity financing. Google essentially has more cash than it can use-- a cash cow.
Income Statement
After thoroughly analyzing the balance sheet, we progressed to the income statement. The key formula for the income statement is revenues (sales) – expenses = net income (profit). Businesses that are operating without a profit will not last very long in the marketplace.
First, we analyzed Google’s profitability. There has been a consistent increase in net income.
Net Income (Millions, USD) Yahoo Change from last yr Google Change from last yr Microsoft Change from last year
2003 105.6 105.6 7,531.00
2004 839.6 695% 399.1 278% 8,168.00 8%
2005 1,896.20 126% 1,465.40 267% 12,254.00 50%
2006 751.4 -60% 3,077.40 110% 12,599.00 3%
The company is growing exponentially. One factor is its increase in overall sales volume (revenue) from $6.1 billion to $10.6 billion. Also, it has been able to reduce the portion of sales devoted to cost of goods sold (variable costs) from 41.89% to 39.67%. Google is thus exhibiting strong economies of scale and improvement of the business process, providing value to all of its stakeholders.
By earning a consistently increasing profit year after year, Google is able to service its debt. However, according to GARP, revenue is recognized when the service is performed, not when the money is received. Thus, cash flow obviously plays a significant role, which will be explored in the following section.
Cash Flow
The third financial statement that must be analyzed is the cash flow statement. It focuses on solvency, having enough cash in the bank to pay off all obligations. By using the “two finger approach”, we identified the principle sources and uses of cash in the business.
The principle sources are from revenue and financing (mainly issuance of common stock). The 2006 figure for issuance of stock decreased substantially from 2005 ($4,372.26 million) to 2006 ($2,384.67 million). This signifies that Google doesn’t have as much need for funding as in 2005. There exists more demand to purchase common stock than Google needs for operating the business.
The principle uses of cash include investing. Google has been making substantial increases in its investing in the last couple years. This is indicative of its shift to maturity. Google is essentially buying growth. Google has more cash than it knows what to do with. Thus, it is important to note that even though Google shows a net change in cash of $-332.50 million for the period ending 2006, it is not at risk for cash flow turmoil. This is simply due to its substantial investment increase.
Google runs over one million servers in data centers around the world,[15] and processes over one billion search requests[16] and about twenty-four petabytes of user-generated data every day.[17][18][19][20] Google's rapid growth since its incorporation has triggered a chain of products, acquisitions, and partnerships beyond the company's core web search engine. The company offers online productivity software, such as its Gmail email software, and social networking tools, including Orkut and, more recently, Google Buzz. Google's products extend to the desktop as well, with applications such as the web browser Google Chrome, the Picasa photo organization and editing software, and the Google Talk instant messaging application. Notably, Google leads the development of the Android mobile phone operating system, used on a number of phones such as the Nexus One and Motorola Droid. Alexa lists the main U.S.-focused google.com site as the Internet's most visited website, and numerous international Google sites (google.co.in, google.co.uk etc.) are in the top hundred, as are several other Google-owned sites such as YouTube, Blogger, and Orkut.[21] Google is also BrandZ's most powerful brand in the world.[22] The dominant market position of Google's services has led to criticism of the company over issues including privacy, copyright, and censorship
Our first analysis of Google begins with the Balance Sheet. The balance sheet is sometimes referred to as a financial snapshot, because it represents the business only at specific time periods.
First, it is essential to evaluate what the business is worth. This brings up what is known as the value problem: involving the conflicting issue between the book value and the market value. The book value of the company is simply the shareholder’s equity, which is found on the balance sheet. This is because the accounting equation, A=L+OE refers to the assets minus the claims against the assets to equal the book value of the company. However, this does not represent Google’s actual value. The market value of the company more accurately reflects the true worth of the corporation. There are two reasons for the discrepancy:
1. Financial statements are transaction based. The transaction figures are recorded when they occurred and entered into the balance sheet. The figures are never adjusted for the time value of money so there is very little relevance. Also, depreciation does not accurately reflect the true worth of assets.
2. Investors buy the stock for expectations of future earnings, not for the underlying value of investors. This is an important distinction, especially in a technology company like Google’s where investors rely so heavily on intangible assets, which are very difficult to assign an intrinsic value to.
The market value of Google was found to be $145.4 Billion. (See Appendix A-1). The market value is calculated by multiplying shares outstanding by the price per share. This is also referred to as market capitalization. Google’s market capitalization compares to $38.4 Billion for Yahoo, its closest competitor. This shows that Google has established an enormous market share, due to its strong core competencies, which will be mentioned later.
To compare the two, market value and book value, we use the Price to Book value ratio, which is found by dividing the company’s market capitalization by the book value of the equity. Google’s Price to Book ratio is 8.67 (See Appendix A-2). It is used to compare the stock’s market value to its book value. As would be expected, the market value of the stock is much greater than the book value. This is because of the intrinsic value of the intangible assets, such as intellectual property, which is not reflected in the financial statements.
Yahoo Google Microsoft
Price to Book 4.192 8.668 7.467
As can be seen by comparing it to the industry standard, the price to book is higher, indicating that the business is almost entirely based on intangibles.
Another important method to evaluate the market’s representation of value is known as the price to earnings ratio. This number compares its current market value per share to the earnings per share. Due to its continually high earnings, Google’s P/E ratio is 42.5 (See Appendix A-3). Price to earnings is at the industry average for other companies in the industry, those in the technology sector.
Yahoo Google Microsoft
Price to Earnings 56.1 42.5 22.0
According to Investopedia, “The P/E is sometimes referred to as the "multiple", because it shows how much investors are willing to pay per dollar of earnings. If a company were currently trading at a multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1 of current earnings”. (Investopedia.com, 2007) Because a company in the technology sector has such a high level of intangible assets, it can be very difficult to evaluate. This is why as we mentioned earlier, the book value is irrelevant. Valuation is based more on expectations of future earnings. Having such a high P/E multiple means that Google needs to consistently hit the high expectations that investors set. As a result, it seems that there may exist more downside than upside with a company in this industry as seen during the tech crash of 2001.
To continue, it is important to see how liquid the business is. Having short-term liquidity will aid the company to meet its short-term obligations when the business is in financial distress. We can use the current ratio, or the quick ratio to measure this. The current ratio includes all current assets divided by all current liabilities. The quick ratio, or acid test, is the more conservative approach because it excludes inventory due to its low resale value. However, it turns out that the two ratios are the same because Google does not carry any inventory. By avoiding use inventory, Google is able to save substantial carrying costs (i.e. storing in warehouses). The quick ratio turns out to be 10.0 (See Appendix A-4, A-5), which is extremely liquid. Generally a ratio above 2.0 is considered positive. However, generally the ratio only has meaning when compared to others in its industry.
Yahoo Google Microsoft
Quick Ratio 2.561 9.995 2.118
Current Ratio 2.561 9.995 2.184
Google’s quick ratio is much higher than its competitors. Thus, it has very little difficulty meeting short-term obligations compared to its competitors.
Next, we analyzed how much working capital Google has. Working capital is used to measure both a company’s efficiency and its financial health (short term). Working capital is calculated by subtracting current liabilities from current assets. Google’s working capital is found to be $11,735,260,000(See Appendix A-6). By itself the figure is insignificant. The large working capital signifies that Google is not in danger of having trouble paying off current liabilities. For further meaning to the working capital figure, we compared it to previous years. This is because working capital provides insight into how efficient the operations are. If money is tied up in inventory or accounts receivable, the company lacks liquidity to pay off obligations.
Year Current Assets Current Liabilities Working Capital
2003 560.2 235.5 324.7
2004 2,693.50 340.4 2,353.10
2005 9,001.10 745.4 8,255.70
2006 13,039.80 1,304.60 11,735.20
The increase in working capital seems like a positive attribute of growth. However, it also can indicate that a company is not operating efficiently. This suggests further analysis into the collection of the company’s current assets (accounts receivable). In fact, its accounts receivable are among the worst in the industry with 35.96 days worth of outstanding sales. (See Appendix A-7). This verifies the null hypothesis that revenues are not being collected in an efficient manner.
Digging deeper, we looked at fixed asset turnover. It is an important measure of capital intensity, with a low turnover implying high intensity. The fixed asset turnover is found to be 4.43(See Appendix A-8). This number gives the investors an idea of how effectively management is using the assets. It is a measure of the productivity of a company’s fixed assets with respect to generating sales. By itself the number is irrelevant though. It must be compared to its competitors.
Yahoo Google Microsoft
Fixed Asset turnover 6.9 4.43 15.3
The above comparison suggests that Google has higher capital intensity than that of its competitors. Also, it suggests possible inefficiency of using its assets.
The total asset turnover is found by dividing sales by assets. It is found to be 0.57. (See Appendix A-9). This figure represents the amount of sales generated for every dollar’s worth of assets in the business. It measures Google’s efficiency in generating revenue with its assets. Generally it is inversely related to profit margin. The lower profit margin it has, the higher its asset turnover will be and vice versa. Sure enough, because Google has a low asset turnover, its profit margin is high. It is found to be .290 or 29%. More importantly, it increased from .239 in 2005. This signifies an asset intensive business. It is consistent with others in its industry (i.e. Yahoo).
Yahoo Google Microsoft
Total Asset Turnover 0.5581 0.5741 0.6363
Another important ratio for analysis is known as Return on Assets. This profitability ratio shows how much a company is earning on its total assets. Thus, it is an indicator of asset performance. Google’s ROA figure is calculated to be 0.1666. (See Appendix A-10). This means that the business earned 17 cents on every dollar tied up in the business from both creditors and owners. It increased from 14.3 cents last year. Thus, it appears to be more effectively using its assets.
Return On Assets Yahoo Google Microsoft
2004 9.15% 12.05% 8.66%
2005 17.51% 14.27% 17.30%
2006 6.53% 16.66% 18.10%
Another key profitability ratio is return on equity used for measuring the efficiency with which a business uses owners’ capital. It measures the percentage of return to owners on their investment (ROI). If investors are not being rewarded for their investment, they will no longer be motivated to invest. There are three levers for controlling ROE: profit margin, asset turnover, and the financial leverage. The Return on Equity was calculated to be 18.047% (See Appendix A-11), an increase of about 2.5% from the previous year. The discrepancy between ROA and ROE can be explained by Google’s small use of financial leverage.
Return On Equity Yahoo Google Microsoft
2004 11.8% 13.6% 10.9%
2005 22.1% 15.6% 25.5%
2006 8.2% 18.1% 31.4%
To continue, we analyzed debt more closely. Having debt can greatly restrict a company’s flexibility. However, Google has no long-term debt. This is because they are able to use entirely equity based financing. There is little inherent financial risk to the business because it has a very conservative capital structure. It does not rely on leverage.
While Google is still exhibiting substantial growth, it is beginning to reach maturity as indicated by its sole use of equity financing. Google essentially has more cash than it can use-- a cash cow.
Income Statement
After thoroughly analyzing the balance sheet, we progressed to the income statement. The key formula for the income statement is revenues (sales) – expenses = net income (profit). Businesses that are operating without a profit will not last very long in the marketplace.
First, we analyzed Google’s profitability. There has been a consistent increase in net income.
Net Income (Millions, USD) Yahoo Change from last yr Google Change from last yr Microsoft Change from last year
2003 105.6 105.6 7,531.00
2004 839.6 695% 399.1 278% 8,168.00 8%
2005 1,896.20 126% 1,465.40 267% 12,254.00 50%
2006 751.4 -60% 3,077.40 110% 12,599.00 3%
The company is growing exponentially. One factor is its increase in overall sales volume (revenue) from $6.1 billion to $10.6 billion. Also, it has been able to reduce the portion of sales devoted to cost of goods sold (variable costs) from 41.89% to 39.67%. Google is thus exhibiting strong economies of scale and improvement of the business process, providing value to all of its stakeholders.
By earning a consistently increasing profit year after year, Google is able to service its debt. However, according to GARP, revenue is recognized when the service is performed, not when the money is received. Thus, cash flow obviously plays a significant role, which will be explored in the following section.
Cash Flow
The third financial statement that must be analyzed is the cash flow statement. It focuses on solvency, having enough cash in the bank to pay off all obligations. By using the “two finger approach”, we identified the principle sources and uses of cash in the business.
The principle sources are from revenue and financing (mainly issuance of common stock). The 2006 figure for issuance of stock decreased substantially from 2005 ($4,372.26 million) to 2006 ($2,384.67 million). This signifies that Google doesn’t have as much need for funding as in 2005. There exists more demand to purchase common stock than Google needs for operating the business.
The principle uses of cash include investing. Google has been making substantial increases in its investing in the last couple years. This is indicative of its shift to maturity. Google is essentially buying growth. Google has more cash than it knows what to do with. Thus, it is important to note that even though Google shows a net change in cash of $-332.50 million for the period ending 2006, it is not at risk for cash flow turmoil. This is simply due to its substantial investment increase.