Can Google’s Finances Compete? We Say Yes

Comparing Google (GOOG) to another technology company like Amazon can cause a great deal of confusion for a finance professional. Google does a fair job at adhering to the basic tenants of finance compared to Amazon, a company with seemingly no regard for financial principals. Still, somehow, Google is treated like an old shoe compared to Amazon. What gives?

We used the Business Ferret’s 12 financial metrics to take a long, hard look at Google’s financial record since 2007. We found some ups and some downs but, overall, a strong financial position. Our analysis summary is below and you can download the PDF report below.

» Download our Google Financial Analysis Report [PDF]

Real and Sustainable Revenue Growth

Google has averaged around 25% real growth rate annually, with the exception of 2009 when it was around 7%. So, the real revenue growth is consistently high and stable at a high level. This helps management confidence and shows that they can consistently offer products and services that customers will pay for.

The problem with this high revenue growth is that it is twice the rate of their sustainable annual revenue growth. Google’s balance sheet cannot sustain this growth year after year; they need to increase their internal resources to finance this growth.

Pricing Policy

Google has an excellent pricing policy. This company does not discount its gross profit margin in order to get more sales. In fact, Google is still raising its gross profit margin searching for its optimum level. The company is getting more and more dollars of gross profit for each additional dollar of revenues.

Microsoft needs to take note: this is how pricing policy should be managed.

Operating Expense Control

The only problem with the highly successful year over year pricing policy is that Google has slipped on the control of the operating expenses cannibalizing the additional pricing strength. Where net income should have continued its upward march, it has stalled out in 2011.

This isn’t deadly … yet. Google needs to take control of this metric or it’s sure to start eating away at their margin.

EBITDA versus Actual Cash Flow

EBITDA, net income, and cash flow before financing all grew nicely over the last several years until 2011 when the operating expenses shot upward. Regardless of the reason it happened in 2011, let’s hope, for their sake, it doesn’t continue.

The company piles an inordinate amount of money into “other assets” – 14% of the total book assets of the company. It is unlikely that these other assets are producing the kind of cash flow that the company’s core operations deliver.

With a little better cash management, Google could be in a position to correct it’s sustainable revenue and operating expense problems.

Excess Cash Flow

The company annually produces a massive amount of excess cash flow and it holds 4 times the amount it produces each year in cash balances. This is a lot of dead resources sitting around. This excess cash lowers the return on assets dramatically and drags down the company’s edge on innovation and competitiveness.

What are you scared of, Google? Spend that cash and keep your strong position!

Return on Assets (ROA)

Google’s return on assets is about one quarter of what it should be. Reallocating the excessive amount of cash balances would correct this. Instead of an average 11% ROA the company’s adjusted ROA would vault to almost 45% annually.

Distributing the excess cash balances would not only raise the ROA but could drive up the stock price.

Working Capital Needs

The company creates plenty of excess working capital but invests that cash flow into other assets. It would be more transparent for the company to distribute the excess working capital than to put it into other less tangible assets with less visible earnings capability.

Debt Financing

For a company to have a truly strong financial position, it needs to use both its cash and its debt wisely. Holding a lot of cash without a lot of debt sounds like a good move but this is never the case. Debt, used wisely, is a lever to increase return on assets and revenues. Hoarded cash just sits around, doing nothing and dragging down the return on assets.

Google has way too little debt, considering how cheap an alternative it is to equity financing. With all the extra cash balances and the financing of the total assets, this company is highly inefficient in the use of its resources.

Cost of Capital

Google on average achieves around 66% of its cost of capital with its return on assets. With more efficient financing arrangements and a reduction in the extra cash balances, it could achieve a ROA that would be almost 3 times its cost of capital.

This would create a huge economic value and a premium to the stock value.

Any questions?

If you have any questions about this analysis, please let us know in the comments below. It’s one thing to see the numbers and graphs, but we want to help you understand the implications, whether you’re a business owner, investor, or just a financial hobbyist.

Relevant:

• Google (and Apple) are still killing it in the mobile market
• Google’s stock prices might be losing steam