The core business of Alphabet Inc.'s Google (GOOG) is selling online advertising space to merchants placed across its products, from Internet search to Gmail and YouTube. In fact, Google is the most visited website in the world. Advertisers can pay the company to have their websites show up in Google search results for specified search terms. Because the number of Google searches conducted per year numbers more than two trillion, the company has a huge user base to leverage for advertising dollars.
Google is expanding its core business and has several ambitious projects in the works. Potential future business segments for the company include smart devices, human longevity research, and urban infrastructure. These projects, however, remain in various phases of research and development and do not generate significant revenue. Financial ratios represent an effective method for analyzing a company's core business. The following financial ratios indicate how Google's core business is performing as of Q1 2020.
Operating Margin
A company's operating margin measures how profitable it is from its actual operations. The operating margin is a valuable metric when analyzing a company's core business since it disregards money the company made outside its normal operations, such as selling off a business segment or cashing in a profitable investment. The operating margin expresses operating income as a percentage of net sales. What constitutes a strong operating margin varies by industry, but across the board, a value above 10% is considered good, and a value above 25% is considered excellent. Google's operating margin is 19% as of the end of March 31, 2020.
Revenue Growth
Revenue growth compares the company's revenue from the most recent quarter to its revenue from the same quarter in the previous fiscal year. A positive value, particularly growth over 10%, signifies the core business is doing well, and the company's products and services are in demand and priced right. Google's first-quarter revenue was 13% higher year-over-year. This is an encouraging sign; it shows merchants are paying for ad placement in Google's search results at an expanding rate.
Price-To-Sales Ratio (P/S)
The price-to-sales ratio divides a company's market capitalization by its last 12 months of revenue. Market capitalization is the total value of all outstanding common stock, determined by multiplying the share price by the number of shares outstanding. The P/S indicates how much value investors place on each dollar of revenue. It is a good measure of whether you are paying too much for the stock based on what a company is actually earning from its business operations. While average P/S ratios vary based on the industry, Google's P/S is currently 6.01, which is moderately higher than average.
Price-To-Earnings (P/E) Ratio
The P/E ratio is the gold standard of valuation metrics--although it's not everything. It compares a company's share price to earnings per share. The ratio indicates whether the stock is priced high, low, or in between based on the company's earnings.
This ratio is good for analyzing the core business because the market tends to be highly efficient. When the core business is doing well, this information is priced into the stock. A high P/E ratio can indicate investors are optimistic about a stock, or it could simply mean the stock is overpriced. A low P/E ratio sometimes suggests a good value buy, perhaps because other investors have failed to discover the company's earnings potential. As of June 5, 2020, Google's P/E ratio is 29.02. While 15x is considered average across the board, Google's P/E ratio falls into the higher range for technology companies, which tend to have higher valuations relative to earnings. This is because of expected future growth, and while a novice investor might see this ratio as indicating Google is overpriced, it could be one that is indeed fairly-valued when considered over the long term.
Debt-To-Equity (D/E) Ratio
Google has big plans to expand its core business in the coming years. Bringing these big ideas to fruition requires capital to finance research and development. Often, companies raise this capital, at least in part, by taking on debt. This tactic can put a company in a precarious financial position, particularly if the economy turns bad. The D/E ratio compares a company's total debt to its equity. A value under 100% is good. As of the end of the 2019 fiscal year, Google's D/E ratio was 0.08, indicating an extremely low debt load compared to its equity. In fact, over the 15-year period from 2005-2020, Google's D/E ratio has never risen above 10%.
