* One of Google’s innovations is having drones deliver packages directly to homes.
* This shows Google’s commitment for continual innovation.
* In the meantime, the company is likely to perform well due to its advertising business.
* The stock remains fairly valued on a long-term earnings growth basis.
We have already heard that Amazon (AMZN) and Domino’s Pizza (DPZ) were testing the use of drones for delivering their products. Google (GOOG) (GOOGL) has recently announced that it is also testing the use of drones for delivery services. It is not clear if the Federal Aviation Administration (FAA) would ever approve of this or if all of the glitches would be worked out with such a system, but the technology does look interesting.
Google calls its drone efforts, Project Wing. The company reported that it used a 5-foot wide single-wing prototype to deliver candy bars, dog treats, water, cattle vaccines, and radios to two farmers in Queensland, Australia earlier this month. This video link shows the drone in action. Google did acknowledge that it would “take years to develop a service with multiple vehicles flying multiple deliveries per day.” The use of drones for delivery does raise a number of safety, logistical and liability issues. It does seem possible that this technology could be approved for use in less-populated, rural areas.
The effort to get drones into the delivery business is an example of Google’s commitment to innovation. Google is also working on a self-driving car, which I wrote about previously. These types of projects are more long-shot goals and will not have a material impact on the business any time soon if ever. However, they are interesting endeavors. So at the very least, the efforts should provide Google with plenty of positive publicity.
Where Google is innovating for the nearer-term in its core business is in internet search and discovery. Google is in the process of improving its app indexing. This involves improvements with allowing mobile users to more efficiently search and find what they are looking for. This includes allowing users to easily discover new apps and to create more engagement for users with apps that they haven’t used in a while. Google is also working on improving the user experience in switching from screen to screen on Android devices. The goal here is to improve the user experience by making switching from screen to screen as seamless as possible.
Advertising is what is currently driving Google’s success as it comprises 90% of total revenue. Although the company’s total revenue continues to grow, the rate of growth has declined in recent years. This was due to the advertising portion of the business maturing. The non-advertising portion of the business is growing at a faster rate than the advertising business. For example, for the first six months of 2014, advertising revenue increased by approximately 18% year-over-year, while non-advertising revenue increased by about 50% year-over-year. Since non-advertising revenue only comprises 10% of total revenue, the material impact on the company’s bottom line from this portion of the business is low. However, as the non-advertising business comprises more of the company’s total revenue over time, Google’s rate of growth is likely to benefit.
Since the advertising business is still increasing at double-digit growth rates, I think that stock will still perform well over the next few years. Google’s total revenue is expected to increase by 11.5% in 2014 and by 18% in 2015. Earnings are also expected to increase at healthy double-digits rates over the same time. Analysts are expecting a 20% increase in earnings for 2014 and a 19% increase for 2015. This is significantly higher than the expected annual earnings growth of the average S&P 500 company of about 10%. Google is fairly valued as its forward PE over its 5-year expected annual earnings growth rate is between one and two at 1.32. This is slightly below the Internet Information Providers industry PEG of 1.55 and slightly below the S&P 500’s PEG of 1.45. Given this fair valuation and above average earnings growth, I expect the stock to outperform the S&P 500 over the next few years.