Google is primarily an advertising company that is based on the Internet. The company has built a family of websites that offer information to users. The search engine and companion sites drive traffic and the Google brand name, and build a database of demographic information. Google then sells ads to companies based on search criteria. The company has established itself as the dominant Internet advertising firm because of its ability to links ads to users in a manner that delivers superior results to advertisers. According to the 2010 Annual Report, Google earns $19.44 billion in revenues from advertising, 66% of which comes from the company's own websites, with the rest coming from Google Network websites. Advertising accounts for two-thirds of the company's total revenue. In this business, Google competes against a number of other firms, including Yahoo and Microsoft. Google also competes indirectly against other, offline, forms of advertising for a place in the promotional mix of advertisers.
Google has a global scope of business, operating in most countries in the world. The company's main website is the world's most popular, but many of its national sites also rank in the top 100 of websites in the world, according to Alexa (2012). In recent years, Google has added a number of other businesses to its product/service mix. The company has introduced a browser, Chrome, that it distributes for free. Google has also introduced a mobile operating system, Android, that has become the number one mobile operating system in the world, with over 50% share in the U.S. smartphone market. In this industry, Apple is the major competitor and the two other major competitors (RIM and Microsoft) saw steeply declining market shares (Wasserman, 2012).
Analysis and Evaluation
Financial ratio analysis is one of the techniques that can be used to analyze the financial statements of publicly traded companies. The ratios measure factors like liquidity, solvency, profitability, managerial efficiency and investment returns (Loth, 2012). These ratios are stable from year to year, and so are the financial statements, since the latter are compiled under Generally Accepted Accounting Principles (GAAP). What this means is that the company's ratios can be easily compared against past performance of the company, and also against competitors. Because online advertising is Google's main business, the most important competitor to take into consideration is Yahoo. There is a case to be made for Microsoft, because that firm competes against Google in three major businesses, but those are minor businesses for Microsoft and therefore the company's financial statements will be reflective more of its major businesses in software and servers. Likewise, Apple is primarily a device-maker, as opposed to an operating system company. Yahoo therefore is the closest competitor to Google and will be the main point of comparison with respect to the financial ratios.
Ideally, a ratio analysis will focus on the full range of ratios, taking ratios from each different category to paint a full picture of the company's financial performance. Thus, this analysis will feature ten ratios from different categories. The formulas used are all readily available online (Loth/Investopedia, 2012), and the data comes from Google's financial statements, which are also readily available online (MSN Moneycentral, 2012). The ratios chosen for this analysis are the current ratio, the cash ratio (liquidity), the debt ratio (debt), the gross margin, operating margin and net margin (profitability), the ROA, ROE and EPS (investment return ratios) and the receivables turnover (managerial efficiency). The results of the ratio calculations are compiled in the following chart:
There are a few different ways to analyze these ratios in order to glean information from them. The first is an analysis of the numbers outright. Normally this analysis takes into account some background information. For example, Google has a current ratio of 5.9, and that is an exceptionally good current ratio, something that would be recognized by a person who had seen a few other current ratios, or had read that 1.0 is usually a benchmark number for a healthy current ratio. As 5.9 is much higher than 1.0, Google's current ratio is therefore very healthy.
Another way to analyze these ratios is to compare trends. For example, the company's debt ratio has increased while its margins have decreased. This indicates that the company is not as profitable as it used to be, and has possible been forced to take on debt in order to finance operations. Context, however, is always required. Knowing that Google has $44 billion in cash on its balance sheet is important, because it tells us that the increase in debt at Google is not related to need, but rather a choice that management has specifically made to increase the amount of debt in the company's capital structure. With respect to trends, having stability if not outright improvement in key ratios is important. Investors prefer to see that the company is stable and that management has control over the different aspects of the business. Most of these ratios show a fairly high degree of stability, even though they move from a period of recession to a period of growth, and even though new businesses such as Android are incorporated into these figures.
The third way to analyze these ratios is to note things between the ratios themselves. For example, the cash ratio is very similar to the current ratio in all three years. This tells us that the bulk of Google's current assets are cash and equivalents. There is a low level of receivables and inventory. Indeed, the lack of inventory is one of the reasons why inventory turnover was not selected for this analysis. Similarly, that the ROE is so similar to the ROA tells us that most of the company's capital structure is in equity, a finding that is confirmed looking at the debt ratio.
In general, Google is in exceptionally healthy financial condition. The company is more liquid than the Pacific Ocean. The company's current and cash ratios are exceptional. Very few companies anywhere can match the liquidity of Google. It is worth noting, however, that two years ago these ratios were much higher. This trend requires further examination. The company has in the past two years had "notes payable/short-term debt" on its books that have taken the current ratio down. As noted, the decision to take on more debt is a likely related to capital structure and the desire to lower the firm's cost of capital, as Google clearly has no financial need to take on debt of any sort. The increase in debt is also reflected in the debt ratio, but because this is most likely the result of a deliberate action of management, and is founded on solid corporate finance principles rather than desperate financial need, the increase in the debt ratio and decrease in the liquidity ratios cannot be taken as a negative.
The company's margins have declined slightly over the past couple of years. The decline appears to have occurred at the gross level, and then trickled down to the other levels. However, some other costs have increased as well. Selling, general and administrative expense has increased from 15.4% of revenues two years ago to 19.3% in FY 2011. The company's costs have increased while its revenues have not. Part of this has to be attributable to Android and Chrome, both of which have costs associated with them, but are not significant generators of revenue directly.
Returns to investors declined even though the company's earnings per share has increased substantially (53%) in the past two years. This would seem to imply that the ROA and ROE should have increased. However, that they didn't should be taken as a sign that the earnings did not grow as fast as the company did. Thus, while earnings growth has been tremendous, the total size of the company (assets) and the book value of the equity have also grown rapidly. That said, both ROA and ROE figures are healthy and the company has only seen modest declines in these measures. The ROE has not declined as quickly as the ROA because Google has increased the amount of debt in the capital structure. This has the effect of propping up the ROE, whereas it does nothing to prop up the ROA. While this is strictly speculative, it is worth asking whether the decline in investment returns at Google is related to the massive cash pile the company is sitting on. Cash does not earn much in this low-interest environment, and is generally going to return much less than the businesses in which Google operates. The more cash Google accumulates, the weaker its investment returns will become, even if the company is otherwise growing rapidly.