GOOGLE

The company we chose to analyze was Google. The reason for this choice was
that Google epitomizes the advancement and innovation in a company. We looked at
Google’s Annual Report for 2006 and analyzed it using ratios, horizontal/vertical and
trend analysis. In addition we looked at its cash flow statements and analyzed the
companies on its solvency. We also compared Google to its nearest competitors namely
Microsoft and Yahoo.

Analysis:
Cash Flow Analysis:
As seen by the cash flow statement, Google has been an aggressive in its
investments over the past 3 years. Their cash flows from operating activities have
increased over three fold from 2004 to 2006. We deem Google has been an aggressive
company due to the fact that they have invested twice their operating activity. Their
investment activity over the years shows that apart from increasing their investments in
property and land, their major investment comes from purchasing of marketable
securities. Though marketable securities are relative safe investments (treasury bills,
commercial paper etc.) the volumes which Google has invested ($26 billion) in them
shows a substantial investment appetite. Thus apart from being aggressive in investing
twice their operating cash flow they have invested a substantial portion in relatively safe
investment options. Over the past three years, Google has had a surplus of cash from their
financing activities. Google went public in 2004 with an IPO which fetched them 1.1
billion dollars and added to their share capital. On the subsequent year, Google came out
with a follow on public offering of 4.3 billion dollar in 2005 and 2.1 billion dollars in
2006. Thus they have always been able to generate huge amounts of capital through their
public offerings which have in-turn been utilized for their aggressive and enormous
appetite to invest in property and marketable securities. Also, this capital has been
utilized for their continued growth and R&D expenditure.

Capital Structure
Google’s change in capital structure is predominantly impacted by the paid in
capital which was received from investors in exchange for stock. Its contribution to
owners equity increased almost 2 fold due to it’s follow up IPO. Thus this was the major
contribution to its change in capital structure. Another observation is that Google has no
debt. Google could consider having some debt which would in turn increase the EPS (as
interest on debt would reduce the PBT) of the shares which would maximize profit for
the shareholders.
Trend Analysis:
Graph 1
12,000,000

10,000,000

8,000,000
$ (in '000s)

Revenues
6,000,000 Expenses
Income - PBIT
4,000,000

2,000,000

0
2002 2003 2004 2005 2006
Year

Graph 1 represents the Revenue, Expense and Profit trends over the past 5 years.
Revenues and Expenses have been rising at a declining rate. This suggests that even
though income/profit is rising, its rate has been declining. One reason why we see this
occurring is that in the past few years is because Google has grown phenomenally and
growing revenues at the same if not faster rate for such a large corporation is a challenge.
Having said this, their profit margins (Table 1) have been increasing over the past 3 years
and an appreciable level. In 2006 having a profit margin of 33% suggests that Google has
a net earning of 0.33 per dollar of sales. Growth in their revenues from 2004 through to
2006 resulted primarily from growth in advertising revenues.

Table 1
Google
2002 2003 2004 2005 2006
all values are in thousands
Revenues 439,508 1,465,934 3,189,223 6,138,560 10,604,917
Change in Revenue
(as %) 234% 118% 92% 73%
Total costs and
expenses 253,042 1,123,470 2,549,031 4,121,282 7,054,921
Change in Cost (as %) 344% 127% 62% 71%
Income from operations 186,466 342,464 640,192 2,017,278 3,549,996
Capital Employed 9,418,957 17,039,840
 Gross Profit Margin 42.43% 23.36% 20.07% 32.86% 33.48%

Yahoo
2004 2005 2006
all values are in thousands
Revenues 3,574,517 5,257,668 6,425,679
Total costs and
expenses 1,543,598 2,053,742 2,808,990
Income from operations 688,581 1,107,725 940,966
Capital Employed 8,566,415 9,160,610

Gross Profit Margin 19.26% 21.07% 14.64%

Microsoft
2002 2003 2004 2005 2006
all values are in thousands
Revenues 28,365,000 32,187,000 36,835,000 39,788,000 44,282,000
Total costs and
expenses 20,093,000 22,642,000 27,801,000 25,227,000 27,810,000
Income from operations 8,272,000 9,545,000 9,034,000 14,561,000 16,472,000
Capital Employed 54,842,000 64,912,000 74,825,000 48,115,000 40,104,000

Gross Profit Margin 29.16% 29.65% 24.53% 36.60% 37.20%

Google’s profit margin has increased in the last 3 years due to a faster pace of increase in
revenue as compared to costs incurred. Their rate of revenue growth has decreased over
time and we expect it to continue behaving in the same manner. This slow down in
growth is due to increasing competition in the market and also the difficulty Google faces
in maintaining the same growth rate is due to the enormity of the company and its rising
revenue growth. Microsoft has a higher gross profit margin due to its phenomenal amount
of capital employed, we can see that they have not utilized their immense capital to their
advantage and their gross profit margin are not as far ahead as it should have been when
compared to Google’s.

Ratios

Liquidity Ratios
Table 2
Yahoo
2005 2006 2006
Total current liabilities 745384 1304587 1,473,994
Total current assets 9001071 13039847 3,750,142

Current Ratio 12.08 10.00 2.54

Current Ratio tells us if the company were to sell of all its assets will it be able to pay off
its immediate debts. This ratio has decreased as compared to previous year but far ahead
of immediate competitor Yahoo. Increase in assets by 45%, liabilities by 75% (chiefly in
Accrued expenses which have increased by 132%) causing the current ratio to fall.

Gearing Ratios
Table 3
Yahoo
2005 2006 2006
Total Liabilities 852856 1433511 2352998
Total Assets 10271813 18473351 11513608
Capital and Reserves 9418957 17039840

Debt to asset ratios 8.30% 7.76% 20.44%

Equity to Asset 91.70% 92.24%

Debt to Equity 9.05% 8.41%

The Debt to Asset Ratio measures the percentage of the company's Total Assets that are
financed with debt (Total Liabilities). The lower the Debt to Asset Ratio, the better, as
companies with high amounts of debt introduce more risk. The debt to asset ratio has
decreased over the year.

Debt to Equity ratio compares the company's dollar amount owed to creditors (Total
Liabilities) to the dollar amount supplied by investors of the company (Total
Stockholder's Equity). The higher the amount of Total Liabilities, the more risky this
company becomes.

Profitability Ratios
Table 4
2005 2006

Gross Profit Margin 32.8624 33.475

Cost of Sales 23.6895 26.68474
Operating Expense to Sales 23.6895 26.68474
Operating Profit to Sales 32.8624 33.475
Net Profit Margin 23.872 29.01905

Gross profit Margin Ratio measures the number of pennies of gross profit made from
each $ of sales. A lower gross profit margin means that the costs need to be under control,
though a higher value does not ascertain positive situation
Cost of sales to sales (%) shows a direct relationship between the cost of the product to
the company and the price for which the company sells that product. The increase is due
to increase in costs insured (traffic acquisition, data centre cost and other transaction
processes). The revenues are sufficient to cover the expenses incurred for operations.

Operating profit to sales measures the performance of the fundamental business

operations conducted by a company .it tells us how well a business is performing in the
activities unique to that business, without accounting for the financing and tax
management policies. They are heavily investing in building the necessary employee and
systems infrastructures required to manage their growth and develop and promote their
products and services, and this may cause their operating margins to decrease. also the
operating margin may decrease as they invest heavily in employees, system infrastructure
and property.

PAT to Sales attempts to summarize the overall economic performance of a company for
a given period. Due to ADSENSE program, operating margin realized is lesser than
advertiser fees from ads on Google network member websites

Investment Ratios
Table 5
Google Yahoo
2005 2006 2005 2006
Return on Owners Equity
(ROOE) 37.80% 86.81%
Weighted Average Cost of
Capital (WACC) 36.00% 34.00%
Return on Capital Employed
(ROCE) 53.74% 109.10%
Return on Total Assets
(ROTA) 19.60% 19.20%
Earnings per share (EPS) 2.43 9.86
Market Price 414 460
PE Ratio 170.37 46.65 32.65 50.12

ROOE is a fundamental measure of the company's overall performance. It tells the

investors how much they will earn for each dollar they invest in the company

ROCE indicates how efficiently an organization uses those resources invested in it,
expressing its profit as a percentage of total capital employed in achieving that profit. For
the investor a high ROCE indicates an efficient use of resources and high returns
ROCE is greater than WACC during both the years. Hence it is a favorable company for
investment. WACC Measures the fair value of the options granted during the year.

EPS is the most widely cited measure of company performance and is a key input into the
process of deciding how much an investor should pay for a share of stock. The no. of
shares issued has remained constant, while revenues have increased
Price-Earning ratio indicates the relationship between market value of the company and
its current earnings. It indicates the growth potential of the company. Thus Google PE
ratio is extremely high which is an indication to investors to invest in Google’s stock.
Yahoo on the other hand has a much lower PE ratio. The evaluation further suggests
reduction in profit margins due to increased costs and competition in the coming years.

Efficiency Ratios
Table 6
2005 2006
Debtors (AR) 687,976 1,322,340
Creditors (AP) 115,575 211,169
Revenues (Sales) 6,138,560 10,604,917
Cost of good sold (cost of revenue) 2,577,088 4,225,027
Curent Assets 9,001,071 13,039,847
Non Current Assets 1,270,742 5,433,504
Total Assets (Current + non current) 10,271,813 18,473,351

Debt t/o Times 8.92 8.02

Debtor Collection Days 40.91 45.51

Creditor turnover times 22.30 20.01

Credito payment days 6.87 7.27

Total Asset turnover 0.60 0.57

Fixed Asset Turnover 4.83 1.95
Current Asset Turnover time 0.68 0.81

Debtor Collection days is the number of days the company takes to collect its payments
from debtors. This ratio has not improved. The company takes on an average of 45 days
to collect money for services rendered. This figure can be further improved by improving
collection through better and continuous follow ups from debtors.

Credit to Payment days are the number of days the company takes to pay its creditors.
Ratio has increased suggesting company takes longer to pay.

Fixed Asset Turnover ratio measures the company’s effectiveness in generating net sales.
The fixed asset turnover has dramatically reduced suggesting that the investments of the
company have not translated into a substantial increase in sales. This could be because in
2006 the company acquired a huge amount of property and equipment and these
acquisitions may not have an immediate effect on the companies’ sales. It would be
interesting to observe the next year’s Fixed Asset t/o ratio to see if these investments
have been utilized and have affected Sales.

Current Asset Turnover Ratio measures the company’s effectiveness in generating

immediate sales. This ratio has also improved over the year, suggesting their current
assets (cash, marketable securities) have had an appreciable impact on the revenue
figures.
 Debt turnover Times is more or less the same when compared over the year. Sales have
improved and also the A/R has grown larger. As a result there is negligible difference in
debtor turnover ratio.

Income Sheet Vertical Analysis

Table 7
2005 2006 % change 2005 % change 2006

Revenues 6,138,560 10,604,917 100.00% 100.00%

Cost of Revenue 2,577,088 4,225,027 41.98% 39.84%

R&D Expenses 599,510 1,228,589 9.77% 11.59%

Marketing & Selling 468,152 849,518 7.63% 8.01%
General % Admin Expenses 386,532 751,787 6.30% 7.09%
Contribution to Google foundation 90,000 0 1.47% 0.00%

Total Cost & Expenses 4,121,282 7,054,921 67.14% 66.52%

Gross Profit on Sales 2,017,278 3,549,996 32.86% 33.48%

Other Income 124,399 461,044 2.03% 4.35%

Provision for income taxes 676,280 933,594 11.02% 8.80%

Net Income 1,465,397 3,077,446 23.87% 29.02%

 Horizontal Analysis of Income Statement

Table 8
2005 2006 absolute Δ in 1000's$ % change over 2005

Revenues 6,138,560 10,604,917 4,466,357 72.76%

Cost of Revenue 2,577,088 4,225,027 1,647,939 63.95%

R&D Expenses 599,510 1,228,589 629,079 104.93%

Marketing & Selling 468,152 849,518 381,366 81.46%
General % Admin Expenses 386,532 751,787 365,255 94.50%
Contribution to Google foundation 90,000 0 -90,000 -100.00%

Total Cost & Expenses 4,121,282 7,054,921 2,933,639 71.18%

Gross Profit on Sales 2,017,278 3,549,996 1,532,718 75.98%

Other Income 124,399 461,044 336,645 270.62%

Provision for income taxes 676,280 933,594 257,314 38.05%

Net Income 1,465,397 3,077,446 1,612,049 110.01%

Observations from Horizontal and Vertical Analysis

1. 64% increase in cost of revenue has lead to 72% increase in revenues
2. Cost of revenue has actually decreased as a percentage of revenues - suggesting
that Google is reducing cost thus in turn increasing profit margin. In proportion to
their revenues, the cost of revenue has decreased approx by 2%
3. Even though its cost has gone up, the revenues has grown at a higher level
4. Cost of revenues increased by $1,647.9 million to $4,225.0 million (or 39.8% of
revenues) in 2006, from $2,577.1 million (or 42.0% of revenues) in 2005. This
increase in dollars was primarily the result of
a. Increase in labor and facilities as a result of increase in headcount
b. Increase in stock based compensation – stock awards.
5. General and administrative expenses increased $365.3 million to $751.8 million
(or 7.1% of revenues) in 2006, from $386.5 million (or 6.3% of revenues) in 2005.
This increase was primarily due to an increase in labor and facilities related costs
of $150.3 million, primarily as a result of a 92% increase in headcount from 2005
to 2006, an increase in professional services fees of $76.3 million and an increase
in depreciation and related costs of $43.4 million.

Earnings Per Share

Graph 2
 Graph 3 – Share price (2005 through 2006)

EPS is the single most important factor in determining the share price. As seen in
the graph above the EPS has been increasing at a steady amount thus suggesting that the
share price has been increasing at a similar amount thus maximizing shareholder value.
Google has announced that they would not be offering any dividend which suggests that
the company is confident that the shareholders would be rewarded by the rise in share
price. As seen in Graph 3 Google’s share price has increased from $200 at the beginning
in 2005 to $500 in 2006. Thus Google is confident that not offering a dividend would not
be a deterrent for its current and perspective share holders.
References:

Google Financial
Statements
Google’s Financial Statements
www.google.com
www.investopedia.com