Last week was a big week for earnings releases by companies that I hold in my Strategy Lab model growth portfolio. I'd like to focus in on Google Inc. and Facebook Inc. in this week's column. I hold both stocks in my model portfolio (and in real life), but what is a reader to do if he or she wants to profit from the online advertising industry and has to select only one of the two stocks? I'll walk you through my thinking.
Readers might recall that my model portfolio invested in Google but not Facebook upon inception in September, 2012. I picked the dominant player in online advertising and was initially skeptical of Facebook's ability to generate ad revenue. This skepticism was not only widespread at the time, but completely wrong. When I realized the strength of Facebook's platform, I added it to the portfolio instead of Twitter, whose IPO was a bit too rich for my taste.
Google is much larger than Facebook today. Excluding the Motorola business, which Google is selling to Lenovo, the Mountain View, Calif.-based online advertising giant brought in $15.7-billion (U.S.) in revenue last quarter. In the same quarter, Facebook brought in $2.6-billion of revenue. In market capitalization, Google is valued at $395-billion while Facebook is worth $156-billion.
So at first glance, Google has six times the revenue of Facebook, but only 2.5 times the market capitalization. If you assume a dollar of Google revenue today is worth as much as a dollar of Facebook revenue today, you'd quickly conclude that Google is the cheaper investment.
But it's almost never the case that a dollar of today's revenue has equal value between the two companies. Facebook has been growing much faster than Google. In fact, Facebook just posted year-over-year revenue growth of 63 per cent compared to Google's revenue growth of 22 per cent. To be clear, both companies are growing at an impressive rate. But Facebook is smaller and faster right now, which is why investors value a dollar of today's revenue higher than they value comparable revenue from Google.
Why focus on revenue rather than earnings? Both companies are very profitable, and today, I don't have a good reason to assume their long-term profitability, as a percentage of revenue, will differ significantly. That might change. But until it does I prefer to keep things simple and explore revenue growth.
In my opinion, there is good reason to assume Facebook will continue to grow faster than Google for the next few years. I'm impressed with how easy it is for small businesses to target a relevant audience with a small budget on Facebook, and there are millions of businesses who have created pages on Facebook but aren't yet advertising on the platform. That seems like a lot of low hanging fruit to go after. Also, Facebook has not yet launched a tool to allow its ads to show up on partner websites. This is something Google has been doing for years, and is responsible for about one-third of total advertising dollars.
There is also compelling evidence to suggest that Facebook has been more successful in mobile advertising than any other company. A whopping 53 per cent of Facebook's ad revenue came from people who viewed these ads on mobile devices, not traditional computers. Facebook is practically ignoring the personal computer market, which might be a brilliant move. It's pushing hard to create new, independent mobile apps such as "Paper," which combines stories from traditional media with friends from your social network. Obviously these apps will, in time, also show relevant ads to users. While there will always be people who complain about any ads, I have found most ads in my Facebook timeline to be interesting and relevant to me.
I believe Facebook will grow faster than Google in the next three years. But that's not a long enough horizon for me. What about the next decade or more? This is where I see more opportunity for Google because of its much more diversified R&D investments. I think we've yet to see exactly how Google can monetize the Android operating system that powers the majority of the world's smartphones or the Chrome operating system that powers Chromebook laptops. We haven't seen what will happen with wearable computers such as Google Glass. And I think there is a lot more growth to come to the world's No. 2 search engine, YouTube.
As an investor, if I had to chose between the two stocks, I'd probably choose Google. It has the better mix of value, leadership and diversification while still posting growth that demands respect. Both companies are leading the industry in different ways, and I think there is a tremendous amount of growth coming to the online advertising market in the next decade. Rather than pick a single winner, I choose to own both stocks now.
Chris Umiastowski