Google vs. Microsoft: Financial Ratio Analysis & Investment

Introduction: Google and Microsoft at a Glance

Google is the leading search engine in the world, and has used the revenues from this position to both expand its search capabilities and to enter new businesses. Google's main search engine is the world's most-visited website (Alexa.com, 2012). This brand has been expanded both geographically and across multiple product line extensions. The brand is the number one search engine in most major markets, the exception being China, where cultural differences and legal troubles have allowed competitor Baidu to become the market leader and the world's fifth-most-visited website (Li & Womack, 2012). Product extensions include Maps, Translate, Scholar, Books, Images, Video, and other similar search-related services. Google also owns Blogger, one of the world's leading blog platforms. Additionally, Google has enjoyed strong growth in recent years as a result of its Android mobile operating system. Android has become the world's largest mobile operating system, with 38.9% market share (Choney, 2011).

Google earns most of its money from advertisements generated through its search queries. Sixty-six percent of this revenue comes from the Google family of sites itself, with a further 30% coming from Google Network websites. Other revenues account for just 4% of the company's total revenue (Google 2010 Annual Report). A total of 48% of the company's revenue comes from the United States. The United Kingdom is the second-largest market for Google, worth 11% of the company's revenues. The company has not monetized to any significant degree either the Android operating system or the Chrome browser, despite the popularity of those products.

By contrast, Microsoft has a relatively low market share in both search and mobile operating systems. Bing, the company's search engine, is ranked #26 on Alexa, below several of Google's national sites and below Yahoo as well. Most of Microsoft's revenue is earned from Windows, which accounts for 27.2% of the company's revenues and 45.2% of its operating profits. Server and Tools accounts for 24.4% of Microsoft's revenue and 24.3% of its operating profits. Online Services, the division that encompasses Bing, earned only 3.8% of the company's revenue and turned an operating loss. Bing's market share did grow 31% in the latest fiscal year, however.

Financial Analysis: Key Ratios Compared

All told, Google's revenues in fiscal year 2011 were $37.9 billion, and its net income was $9.7 billion. By contrast, Microsoft earned $69.9 billion in revenues and $23.1 billion in net income. Extrapolating search revenue from this data, Google earned $36.4 billion in revenue from its search properties, while Microsoft earned $2.65 billion. Google's domination of mobile operating systems is similarly pronounced. While some observers feel that Microsoft will eventually rise to prominence in this field, the companies currently trailing Google include Symbian, Apple, and Research in Motion.

Liquidity and Profitability

This section presents a comprehensive financial analysis of these two companies using a selected set of financial ratios. These include the current ratio, ROA, ROE, debt ratio, fixed asset turnover, dividend payout ratio, and the price-to-earnings (P/E) ratio. Financial ratios are often used to compare different companies because they are based on financial statements produced according to the same set of rules — generally accepted accounting principles (GAAP). As such, there is a high degree of comparability between figures, especially when comparing companies in the same industry. There are many similarities between Microsoft and Google, but there are also a number of differences that must be taken into consideration when making a final investment decision.

The first ratio to be discussed is the current ratio, which is a measure of the company's liquidity. The formula for the current ratio is current assets divided by current liabilities. Current assets are those that are easy to liquidate and can therefore be used to pay down the firm's near-term obligations. In general, a current ratio above 1.0 is considered healthy — the higher the number, the stronger the firm's liquidity position. Google's current ratio is 5.9, compared with 10.6 two years prior. Both figures are outstanding. As of the end of fiscal 2011, Microsoft's current ratio was 2.6, compared with 1.8 two years earlier. The upward trend for Microsoft is noteworthy, as it indicates improving liquidity over the past couple of years. Google's declining trend is less significant — 5.9 is an exceptional current ratio, so the fact that it was nearly double that figure two years ago is not a major concern. Google remains one of the most liquid companies in the market. Microsoft, for its part, also maintains high liquidity; its cash ratio is 1.8, meaning that the majority of its current assets are held in cash, leaving it well positioned to cover near-term obligations.

The second set of ratios to be analyzed is return on assets (ROA) and return on equity (ROE), both key profitability indicators. Return on assets measures the company's ability to convert its assets into profit, while return on equity measures the company's ability to convert its equity into profit. ROA is the more directly comparable figure between the two companies, since both firms have a similar asset structure to support their revenue-generating activities. ROE is less directly comparable because it is affected by each company's capital structure decisions. Firms often take on debt to lower their cost of capital; the resulting leverage means that shareholders earn better returns because more of the company's profits flow to a smaller equity base.

According to MSN Moneycentral, Google's return on assets is 14.9% and its return on equity is 18.66%. The five-year ROA is 16.5% and the five-year ROE is 19.4% — all figures slightly above industry averages. That Google's investment returns have dipped slightly over the five-year period is mildly discouraging, particularly given that the company did not experience a severe business slump during the recession. That it remains ahead of industry averages is, however, a positive sign. Microsoft's ROA is 22.9% and its ROE is 41.68%, with a five-year average ROA of 22.7% and a five-year average ROE of 43.7% (MSN Moneycentral, 2012). These figures are well above industry averages — though it should be noted that Microsoft operates in a different industry classification than Google. Microsoft's consistently superior returns indicate a stable, high-performing business. There has been a slight dip in ROE, but overall performance remains strong. Comparing the two companies, both perform well on profitability measures. Microsoft's figures are superior, but its industry generally carries higher baseline returns. Furthermore, Microsoft's ROE of 41.68% substantially exceeds Google's 18.66%, a difference that reflects the higher degree of leverage in Microsoft's capital structure: with more debt, Microsoft can deliver higher returns to shareholders than Google, which carries very little long-term debt.