Last week Google announced a major corporate change. They're forming a new company called "Alphabet," which will be a holding company. Alphabet will house all of Google's non-traditional assets as separate companies, as well as a cleaner, more focused business that keeps the name "Google." It seems to me as though Sergey Brin and Larry Page are attempting to create a Berkshire Hathaway of the technology industry. This could be an important step toward allowing Google to feel comfortable making bigger bets outside of its traditional market. Given my long-term focus on stocks, I think it's good news.
Google has been a solid performer for me. Since Strategy Lab launched in September, 2012, Google is up about 86 per cent while the S&P 500 is up 43 per cent. That's a market-crushing result no matter how you look at it. But Google has always looked like one of the cheaper stocks in my portfolio. The stock trades just under 23 times this year's consensus earnings-per-share estimate, and under 20 times next year's EPS estimate.
Let's compare that to Facebook, which trades at 45 times this year's analyst estimate and 34 times next year's estimate. Facebook is more expensive on a price to earnings (P/E) basis. People who spend too much time looking at P/E ratios tend to shy away from stocks such as Facebook. But look at the performance! If I had put Facebook in my Strategy Lab portfolio instead of Google, I'd be up 325 per cent.
If you've been reading this column for a while, you might remember that I was not a fan of Facebook at the time of portfolio inception. I came around only when I saw how effective the company was becoming at launching amazing advertising tools and helping advertisers target mobile users.
Since getting on board (and buying the stock), Facebook is up well over 100 per cent and it still looks expensive to value investors. But in my 20 years of growth investing, I can't recall a single time I've made good money buying cheap stocks. Instead, I think it's important to realize that strong performers will have a history of hitting new highs. They'll have great past price appreciation and it's crucial to see that past performance as a good thing, not something to worry about.
Past price appreciation suggests Facebook is the better stock. But what about business results? It seems as if Google's search business is being beaten out by Facebook's social business. I just finished reading an article from Fortune.com referencing an interview they conduced with the CTO of analytics firm Parse.ly. He claims that Facebook now refers more traffic to news sites than Google. This resonates with me because in business circles I hear a lot more discussion about advertising on Facebook these days compared to Google. Social sharing is powerful, and there is no question Facebook crushes Google here. Some people think Facebook is just a big time-waster and a passing fad. I strongly disagree. I'm watching Facebook turn into the ultimate tool for businesses to communicate directly with customers.
Doesn't this make Google second-best? Why not just buy Facebook? If I had to pick only one, it would certainly be Facebook today, whereas in the past I preferred Google. But I still expect Google to beat the market. There are plenty of opportunities within YouTube and Android to generate growth, and there are plenty of opportunities outside of the traditional Internet search business, including home automation and development of autonomous cars. But it's hard for the average investor to get excited about these opportunities when they are deeply buried within Google and sorely lacking in terms of financial disclosure. The creation of Alphabet should not only provide better disclosure, but put appropriate pressure on management to deliver strong results.
Much like Warren Buffett's Berkshire Hathaway has returned market-beating results to shareholders, I think Google offers that same opportunity in the technology market. I'm happy to see management organize its portfolio of companies inside of Alphabet. It tells me they're still thinking very long-term.