Google Business Models

Google and Microsoft are competitors in two different businesses, search engines and mobile operating systems. Google is the industry leader in search engines, garnering massive amounts of traffic on its different sites. Google has a number of different search sites (maps, scholar, images, translate) that are in line with its mandate to make information more freely accessible. The company's Android mobile operating system has become a major product for the firm, spurring strong growth in the past few years. Android is licensed by OEM companies (smartphone and tablet makers) to use as an operating system. Much of Google's revenue comes from advertisement sales, which are based on search terms and customer information that has been gathered. The company holds a dominant position in this market.

Microsoft's main business is in the Windows operating system and in the company's suite of software. These generate revenues both from OEM computer makers and from end users. The company has a major corporate market as well, including both software and a range of enterprise solutions. Microsoft launched Bing as one of its online properties, but Bing remains much smaller than Google in terms of market share. Microsoft also has a mobile operating system that trails Android by some distance as well. The other major business for Microsoft -- a business in which it does not compete with Google -- is in gaming, with its Xbox property.

Both companies target broad audiences with mass market products, yet both are also focused on earning high margins on those products through differentiation. Both are global companies, though earning the bulk of their revenues from the American market. Both firms have undertaken moves into entirely different product segments in order to augment their businesses and utilize some of the excess capital that they have. There are, therefore, many similarities between these companies.

Financial Analysis

Financial ratio analysis is a means of comparing different companies. Ratios are based on financial statements, which are compiled in accordance with generally accepted accounting principles (GAAP) so that the statements are roughly comparable with one another. This is especially true of firms that compete in the same industry. Google and Microsoft are close enough competitors that ratio analysis is a fair way to analyze the differences between the two of them and determine which company is financially stronger and which one is the better investment.

The first type of ratio to be analyzed is the liquidity ratio group. The most important liquidity ratio is the current ratio. This is a measure of the firm's capacity to meet its financial obligations for the next year, by comparing those obligations to the assets that can be easily liquidated in the coming year. The formula for the current ratio is the current assets divided by the current liabilities. Both of these firms are incredibly wealthy, so both should have fairly high current ratios. Google's current ratio at the end of FY 2011 was 5.91, while Microsoft's current ratio was 2.6. This means that while both firms are very liquid, Google is exceptionally so.

The return on assets (ROA) and return on equity (ROE) statistics measure the ability of the company to convert its assets and its equity into profits. The higher these metrics are the better. For Google, the ROA is 14.9% and the ROE is 18.66%. For Microsoft, the ROA is 22.9% and the ROE is 41.68%. These figures indicate that Microsoft has the better investment returns in both categories. The company's exceptional profits are very high in relation to its asset base and to owner's equity. The latter could well be a function of higher debt levels in its capital structure.

The debt ratio is one of the indicators of the firm's capital structure. A high debt ratio signifies that the firm is heavily leveraged. A high degree of leverage reflects a high degree of risk in the firm, as more of the firm's cash flows from operations must be diverted to debt service. However, this high leverage provides shareholders with superior returns, and debt financing costs less than equity financing. For those reasons, some firms prefer to have a high level of debt. The key to understanding the debt ratio, therefore, is to know when a company is in a difficult financial situation, or when its debt levels are not entirely within the company's control (i.e. they exist to cover steep losses). Google's debt ratio is 0.2, while Microsoft's is 0.47. Google has very little long-term...

Microsoft's debt level is by choice. There are two reasons we know this. The first is that the company has enough cash ($52.7 billion) to pay down its long-term debt ($11.9 billion) entirely should it so desire. The other reason is because the debt ratio has changed little in the past five years -- the company is clearly maintaining its capital structure in its current range, and is likely doing so in order to lower its cost of capital.
Measures of operating performance should also be taken into consideration. One such measure is the fixed asset turnover ratio, which relates the company's fixed assets to its sales. The higher this figure, the better job the company is doing of generating revenue from its fixed assets. This is perhaps not the best operating ratio to use for tech companies, as they tend to rely more on non-fixed assets like their employees and their patents to generate revenue. That said, Google's fixed asset turnover is 06 and Microsoft's is 0.7. Again, this indicates that Microsoft utilizes its assets a little bit better than Google does in terms of generating revenue.

Dividend payout is not a measure of performance, but does reflect the degree to which the firm uses dividends as a means of returning investment to shareholders, rather than relying on capital gains. Both firms clearly can afford to pay dividends, so it is simply a question of doing so. Google has never paid a dividend, but Microsoft does. Its dividend payout ratio is 2.49%, or $0.80 per annum. These dividends reflect a choice on the part of the business, but the fact that Microsoft has some mature businesses is likely the reason why it has decided to pay a dividend as an enticement to investors.

The final measure is the price/earnings ratio. This again is not necessarily indicative of the company's performance. The denominator is, of course, but the price of the stock is a reflection of a number of factors. Market expectations of the firm's future performance are one of the major components of share price, but beyond firm-specific factors both the market risk and the basic risk in the economy are also taken into account. The P/E, nevertheless, remains an approximate proxy for market expectations of the firm's future performance. High growth firms will tend to have high P/E ratios. Both of these companies has high earnings (Google's EPS is $30.17 and Microsoft's is $2.76) so those will affect the EPS. Google's P/E ratio is 20.64, while Microsoft's is 11.52, despite Google's higher EPS figure. Google's stock trades in excess of $600 while Microsoft's is just over $30.

The Investment Decision

These ratios are helpful in making an investment decision. For example, the ROA and ROE are important because they reflect the degree to which your investment will be put to use. The ROA is less useful because it implies that your investment on the secondary market will contribute to the firm's assets, which is false. However, the ROE is very useful as a measure because it reflects the ability of the firm to convert the shareholders' equity into profits, something that very much concerns somebody buying the stock on the market.

The P/E and dividend payout ratios are also very much important. The latter is useful in this case because the investor must understand that with Microsoft there is a de facto guarantee of the dividend (given the company's cash position) whereas the total return on Google stock will be entirely based on capital gains. In either case, an investor should probably assume that with high profile companies like this that the efficient market hypothesis holds -- probably in strong form -- so that relying on either capital gains or unexpected increases in dividends is closer to gambling than investing.

This is where the analysis of the firm's business model comes into play. Every investor has his or her own interpretation of what the company's future is going to be. Thus, if the investor understands that more or less the stock is trading at fair value, he or she can still capitalize on downturns on the company's stock, if small movements minute to minute are assumed to be temporary irrationality.

The price/earnings ratio is also important because it is useful to know what the market sentiment regarding a stock is. For Google, the high EPS would indicate that perhaps the company's P/E ratio could not be large, but it is still larger than that of Microsoft. This reflects the market's interpretation that Google has more business potential than does Microsoft.…