Goog vs. Msft What Is Google\'s Business

GOOG vs. MSFT

What is Google's Business Model?

According to its latest 10-K, Google earns over 96% of its revenue from online advertising. The company's advertising programs, such as AdSense, are supported by the power of its search engines, which match keywords from websites or search terms with advertising. The result of this is that Google's results are the most robust on the Internet and its customers derive more value than customers of other advertising engines. It does not hurt that Google's websites are the most used on the Internet, with its core website Google.com being the number one ranked site on the Internet by traffic (Alexa.com, 2012).

While Microsoft has a search business, the company is not oriented as strongly towards it. Bing is the search engine and is ranked #26 in the world by Alexa. Bing is affiliated, however, with Yahoo and that site is the #4 ranked website in the world. According to its most recent annual report, Microsoft's most valuable businesses in terms of revenue are Windows, Servers and Office. Bing is part of the Online business group, which is a small part of the company's revenue and did not make money in the last fiscal year. The Xbox is another major business for Microsoft. The company also competes directly against Google in mobile operating systems, but Microsoft is not an important player in this market. Google's Android holds the number one market share, but does not seem to generate much revenue for the company.

In terms of leadership, Google is a very innovative website. It has a focus on making information more freely available, and this is something that drives a lot of traffic to the Google family of websites. The company continually innovates, and this has included new business lines like Android and Chrome that take the company into the realm of software maker, rather than just being an Internet company. Microsoft's core businesses are significantly older, having risen to prominence in the mid-90s. They are more mature as well, having been diffused around the world already. Microsoft has entered new businesses in the past decade, but for the most part it was not the first mover, not the innovator and has struggled to carve out a dominant position in these industries. The company's leadership style has therefore become more conservative, and Microsoft spends a lot of managerial energy nursing its cash cow core businesses.

Google, by contrast, sees itself as a growth company. The company is still seeking out new opportunities and challenges. It is trying to compete harder in China, one of the only countries in the world where it does not have a dominant market share. Microsoft is also seeking new businesses opportunities because it has a lot of capital, but it also pays a fairly high dividend payout ratio, which indicates that management and the company's investors see it as more of a mature business. That Google has the P/E multiple it has despite not offering a dividend shows that its investors agree with management that the company still has tremendous growth opportunities.

Which Company is Better Prepared to Weather a Recession?

The evidence from the last recession shows that Google continued to gain in revenue during the entire last recession, whereas Microsoft saw its revenues decline during the 2009 fiscal year. This leads one to conclude that Google is essentially recession-proof, but there are other considerations to take into account.

The first is the debt ratio for the two companies. The more debt a company has, the more of its free cash flow must be dedicated to debt service. This increases the risk of the company becoming insolvent, which is something that would happen were either of these two firms collapse in the face of a recession. The balance sheets of both companies indicate that they are nowhere near being insolvent, since both have tens of billions of dollars in cash. Google's current ratio in particular is ridiculous at 5.9, which Microsoft's is merely very good. The same can be said of the debt ratio. Both companies have only recently been taking on long-term debt, but Google still has a debt ratio of only 19.9%, whereas Microsoft has one of 47.4%. Basically, the higher debt ratio makes Microsoft riskier, even though it has over $50 billion in cash in the bank. As a result, we can safely conclude that while both companies are in an incredibly good position, Google is better equipped to withstand a recession because it has a more recession-proof business and much lower debt levels.

What do the Profitability Ratios tell us?

The profitability ratios tell us different things, but they are measures of how well these companies convert their assets and equity into profit for the shareholders. Microsoft has the higher ROA and ROE figures, compared with Google. This is important for investors because it indicate that Microsoft has a high rate of efficiency in its ability to convert its assets into profits. Additionally, Microsoft's ROE is much higher. Consider the debt ratio -- debt is a factor in the equity that is the denominator in the ROE. A company with a high debt level will have lower equity relative to the size of the company. When that happens, the ROE is typically higher. This is actually one of the reasons why companies take on debt -- because it enhances returns to their shareholders. For Microsoft, the debt that it has taken on is clearly reflected in a very high ROE figure, higher even than Google with its stellar performance.

Finance-based guidelines

There are a number of guidelines that can be used to gauge the investment quality of these two companies. The first of these is the price/earnings ratio. In general, this reflects the opinion of investors about the future prospects of the company. The more investors think the company is going to grow, the higher the P/E ratio will be. Google has a P/E ratio of 20, and Microsoft's is 11. This says that the investors believe Google has better growth potential. This finding corresponds with the other signals that the market has. For example, Google does not pay a dividend, something that a growth company would do, while Microsoft actually pays out quite a bit of its earnings as dividend, something a slow growth company would do.

Additionally, Google has the better innovation culture and has been the better innovator in recent years. Where Microsoft has no growth potential, like in mobile operating systems, Google rises to prominence quickly. Bing is second fiddle to Google (third if you count Baidu), and seems destined to remain that way. Simply put, the market's assessment of Google corresponds with the strategy and management style of these two firms.

Another valuable metric is the dividend payout ratio. This is important because there are two components to an investment's total return. If it is assumed that the stock price reflects fair value for the company, then we can see that Google will grow at approximately twice the rate of Microsoft in the coming years. However, Google guarantees nothing to its shareholders, meaning that those shareholders could face unmitigated losses from their ownership of Google stock. Microsoft shareholders, however, will receive regular dividends. This provides some insulation from declines in the company's stock price, and that is important for a lot of investors, especially those who find that strong growth from a company like Google that already has a $608 share price is unlikely.