Google vs. Berkshire Hathaway: Is Google a Value Investment?
The name Google (NASDAQ: GOOG) does not come to mind when you think about value investments, but perhaps it should. The search engine titan has some surprising and intriguing similarities to the ultimate value company: Warren Buffett’s Berkshire Hathaway (NYSE: BRK.A).
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Both companies are growing at an impressive rate even as they defy Wall Street logic. Google reported a quarterly year to year TTM revenue growth rate of 15.25% and a quarterly profit margin of 26.28% on Dec. 31, 2014. Those numbers certainly worked for stockholders; they produced a return on equity of 15.11%. Berkshire Hathaway reported a quarterly year to year TTM revenue growth rate of 10.01% and a quarterly profit margin of 9.02% on Sept. 30, 2014, which produced a return on equity of 9.17%.
The raw numbers seem to indicate that Google is a better company than Berk Hath, but is it? Berkshire Hathaway reported a net income of $20.71 billion and a free cash flow of $8.24 billion on Sept. 30, while Google reported a net income of $14.44 billion and a free cash flow of $2.813 billion on Dec. 31, 2014.
Cash Is King: Why Google Won’t Pay a Dividend
See the similarity here: both companies generate a lot of cash and keep it. Larry Page and Warren Buffett both seem to believe in cash and a lot of it. They also have something else in common—neither Berkshire Hathaway nor Google pays a dividend. The last time Berkshire Hathaway paid a dividend was 1967, when the Beetles were still on tour. Google has never paid a dividend, and I strongly suspect that it never will.
Instead of paying a dividend, Page and Buffett hold on to the cash and use it to grow their companies. Both companies face constant pressure from stockholders to pay a dividend, and they ignore it. One of the ways both Google and Berkshire Hathaway use that cash is to generate float.
Floating on Cash
“Float,” or available reserve, is a pool of cash that a company can tap at any time. Berkshire Hathaway gets most of its insurance from insurance premiums. It wholly owns the auto insurance giant GEICO and other insurance companies. The premiums are guaranteed income that’s always there for Buffett to play with or borrow against.
Investopedia’s Greg McFarlane estimated Berkshire Hathaway’s float at $77 billion. Buffett is in some other businesses that are heavy float generators, including newspapers and the business jet rental organization NetJets. Newspapers historically generated float through subscriptions, and NetJets makes money through contract agreements.
Having all that float puts Uncle Warren in a great position to take advantage of opportunities when they arise; for example, when Warren sees a good company he can acquire at a low price or a chance to buy back stock.
Google generates float through its sites’ revenues and network revenues. In the first quarter of 2014 the sites generated $10.47 billion, or 68% of Google’s total revenue. During the same quarter the network revenues generated $3.4 billion, or 22% of Google’s revenues. This gives Google lots of money to play with and to invest in things like self-driving cars and military robots.
How Google Collects Toll
Most of these revenues come from Internet advertising over which Google has been accused of having a semi-monopoly. If you want to make money from your website, you basically have no choice but to install Google AdSense or DoubleClick. If you want to advertise online, you will probably use Google AdWords sooner or later.
This is similar to Buffett’s modus operandi because Google acts as a sort of toll taker on the information superhighway. If you want to go online and do business, you will have to pay Google’s toll sooner or later whether you like it or not.
Buffett has invested in similar monopolies, such as newspapers. Back before 2000, if you wanted to advertise in the average American or Canadian city, you did business with the local daily newspaper whether you wanted to or not. In those days, the newspaper had an effective monopoly on most advertising, including classified ads.
Yes there was television and radio, but most advertisers could not afford those mediums. In many cities, owning a daily was a license to print money because everybody from the guy running a garage store to the car dealer had to buy advertising sooner or later. I remember working in the newspaper industry back then; in many cities, the newspaper had one of the biggest and most impressive buildings in an impressive location downtown because of the cash it generated.
Google has effectively devastated the newspaper industry and a variety of other monopolies—such as phone books and directories—by stealing a large percentage of their advertising revenues. Basically, Page and his cohorts figured out how to steal those companies’ float and divert it for their own purposes.
Cashing In on Information
This brings us to the most intriguing similarity between Google and Berkshire Hathaway: they are both based on information. Buffett built his company by carefully gathering and analyzing information about companies and stocks and using it to spot opportunities. He famously reads companies’ earnings reports and SEC filings for fun.
Google’s core business is the collection and analysis of data, which allows it to identify opportunities and capitalize on them. It generates ad revenue by monitoring and analyzing Internet traffic. By understanding web traffic, Google can figure out where to build the toll booth.
Two tenets of Google’s corporate philosophy are: “There’s always more information out there” and “The need for information crosses all borders.” Those tenets explain everything from the Google Car to Google Express.
Many of Google’s high profile research projects, including Google Maps, Google Express, and the self-driving car, are designed to collect data and let Google identify more opportunities to make money. The delivery service Google Express will give Google a vast amount of data about customers’ shopping habits that it can sell or rent out.
Cramer’s Right, and Yes, Google Is a Value Investment
Now for the big question: Could Google ever become as big or as rich as Berkshire Hathaway? The answer is yes; if Google keeps up its current level of growth, its profitability rivals Berkshire Hathaway’s. If Google could grow like it has for the next 20 or 30 years, it could reach Berkshire levels.
That also means that Google’s stock could one day be as valuable as Berkshire Hathaway’s, if you’re willing to wait. Right now, I agree with Jim Cramer; Google’s stock is undervalued, and it was trading for $543.68 a share on Feb. 19. If you want a stock to hold for the long term, and I mean the long term, Google would be perfect.
One reason why Google is a great stock is the final and perhaps most important similarity between Google and Berkshire Hathaway. The management at both companies has the ability to ignore Wall Street and the financial media and do what’s best for their companies. That kind of focused decision making is rare, and it is perhaps the most valuable asset these two companies have. So yes, folks, Google is a value investment.
Disclosure: The author uses some Google Advertising solutions, including AdWords and AdSense.