In this blog, we have been somewhat bearish on Google from the very beginning. The seasonal trends are putting a tail wind into the internet stocks from Google to Amazon.com. One might argue that we are in a bull market now and every stock has gone up. While this is true, let us compare two companies, KO and GOOG and see where they stand from the balance sheet perspective.
Almost all the readers here should be familiar with Coke and Google. Coke is an old world company that has been around for more than hundred years. It has with stood competition and idiotic management over the course of its existence. Google on the other hand is an internet darling and has been growing revenues and earnings at an exponential rate. Google is a young company with smart founders with a new business model.
Coca Cola is fully valued at the moment when compared to the long bond. Google on the other hand fully valued against its future (2007/2008) earnings. In this segment we will look at some financial ratios to see which offers enduring competitive advantage and a long term buy opportunity. In the short term, Google definitely has more upside as momentum investors jump in to make a quick buck.
First comparison of earning yield. Based on the long bond ratios, Coke is fairly valued at today's market. Google has to earn ~$23 to be on par with Coke regarding price compared to the long bond. Google is not expected to earn $23/share till about 2009-2010.
Coke is a slowly growing company. In the last ten years, its EPS has increased from 1.40/share to 2.24/share. The EPS has grown at 4.8%/year in that period. The total outstanding shares have decreased somewhat. The dividends have increased by 55% in the past five years and the company roughly gives out about 50% of its earnings in dividends. The operating cash flow in Coke has increased from 3.43 billion to about 5.77 billion in the ten year period - a 5.3% increase per year. The free cash flow has increased at the rate of about 6.3% per year in the same period. The return on equity and return on assets have been in the double digits in that time.
Google is a fast growing company. The EPS for Google went from 41 cents a share in 2003 and is on track to hit almost $10 a share this year. The revenue growth rate in the past two years has been 100% and 70% respectively. The growth is slowing to about 40% range next year and will probably go to the 30% range in the year after. Googles cash flow has increased from 218 million in 2003 to 1.5 billion in 2006. The cash flow in 2006 is less than that of 2005 because of larger capital expenditures. Googles return on equity is less than that of Coke in the last two years whereas the return on assets is higher by a couple of points.
The return on equity is an important metric. If we look back at the 1977 Berkshire Hathaway annual letters, Warren Buffett has this to say about earning per share and managerial performance. "Except for special cases, we believe a more appropriate measure of managerial economic performance to be return on equity capital. In 1977 our operating earnings on beginning equity capital amounted to 19%, slightly better than last year and above both our own long-term average and that of American industry in aggregate. But, while our operating earning per share were up 37% from the year before, our beginning capital was up 24%, making the gain in earnings per share considerably less impressive than it might appear at first glance" He goes on to discuss why return on equity is an important metric in the subsequent annual letters.
To sumarize the above points, KO has a free cash flow of 4.5 billion where as Google has a free cash flow of 1.5 billion. Coke's return on equity is higher than that of Google whereas Google has a slightly higher return on assets compared to Coke. Coke's return on equity is better than that of Google by about 10 percentage points. However, Cokes market cap is 110 billion compared to Google's market cap of 155 billion.
We will finish off this article by looking at the various valuation ratios of the two companies. The trailing PE for Google is 74, price to book is 11.6, price to sales is 19 and price to cashflow is 52. The forward PE for Google is 50.
Coke on the other hand has a P/E of 21, price to book of 6, price to sales 5, price to cash flow ratio of 29.5. The forward PE for Coke is 18.6.
Based on these factors, each investor can make a decision for themselves which business is superior and which business is cheaper at the moment.