The core business of Alphabet Inc.'s Google (NASDAQ: GOOG) is selling online advertising space to merchants placed across its products from internet search to Gmail to YouTube. Google is the most visited website in the world. Advertisers can pay the company to have their websites show up in Google search results for specified search terms. Because the number of Google searches conducted per year is over 1 trillion, the company has a huge user base to leverage for advertising dollars.
As of 2018, Google is expanding its core business and has several ambitious projects in the works. Potential future business segments for the company include smart devices, human longevity research and urban infrastructure. These projects, however, remain in various phases of research and development and do not generate significant revenue. Financial ratios represent an effective method for analyzing a company's core business. The following financial ratios indicate how Google's core business is performing as of Q2 2018.
A company's operating margin measures how profitable it is from its actual operations. The operating margin is a valuable metric when analyzing a company's core business since it disregards money the company made outside its normal operations, such as selling off a business segment or cashing in a profitable investment. Operating margin expresses operating income as a percentage of net sales. What constitutes a strong operating margin varies by industry, but across the board, a value above 10% is considered good and a value above 25% is considered excellent. Google's operating margin is just about there with 24.12%.
Revenue growth compares the company's revenue from the most recent quarter to its revenue from the same quarter in the previous fiscal year. A positive value, particularly growth over 10%, signifies the core business is doing well and the company's products and services are in demand and priced right. Google's second-quarter revenue for 2018 was 24% higher than its same-quarter revenue for 2017. This is an encouraging sign; it shows merchants are paying for ad placement in Google's search results at an expanding rate. In fact, between 2005 and 2018, Alphabet saw a median rate of annual revenue growth of 23.2%.
Price-to-Sales Ratio (P/S)
The P/S divides a company's market capitalization by its last 12 months of revenue. Market capitalization is the total value of all outstanding common stock, determined by multiplying the share price by the number of shares outstanding. The P/S indicates how much value investors place on each dollar of revenue. It is a good measure of whether you are paying too much for the stock based on what a company is actually earning from its business operations. A low P/S often reveals a good value play. Google's P/S is currently 6.32, which is moderately higher than average.
Price-to-Earnings (P/E) Ratio
The P/E ratio is the gold standard of valuation metrics. It compares a company's share price to earnings per share. The ratio indicates whether the stock is priced high, low or in between based on the company's earnings.
This ratio is good for analyzing the core business because the market tends to be highly efficient. When the core business is doing well, this information is priced into the stock. A high P/E ratio can indicate investors are optimistic about a stock, or it could simply mean the stock is overpriced. A low P/E ratio sometimes suggests a good value buy, perhaps because other investors have failed to discover the company's earnings potential. Google's P/E ratio is 48.23x. While 15x is considered average across the board, Google's P/E ratio falls into the average range for technology companies, which tend to have higher valuations relative to earnings.
Debt-to-Equity (D/E) Ratio
Google has big plans to expand its core business in the coming years. Bringing these big ideas to fruition requires capital to finance research and development. Often, companies raise this capital, at least in part, by taking on debt. This tactic can put a company in a precarious financial position, particularly if the economy turns bad. The D/E ratio compares a company's total debt to its equity. A value under 100% is good. As of Q2 2018, Google's D/E ratio is just 2%, indicating an extremely low debt load compared to its equity. In fact, the over the 13-year period 2005-2018, Google's D/E ratio never rose above 10%.