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Krause Fund Research Spring 2015

IT Services` Recommendation: BUY Analysts

Adam Ishola Adam-ishola@uiowa.edu

Adrien Voellinger Adrien-voellinger@uiowa.edu

Jared Mandel Jared-mandel@uiowa.edu

Company Overview Google (NASDAQ: GOOG) is the dominant firm leader in the search engine and online advertising industry. The company generates advertising revenues both through paid advertising on their property websites and cost-per-click revenues on their network member websites, utilizing their dynamic, proprietary search software—such as AdSense—to generate cost-per-click revenue. Google’s operations stem from the search engine and online advertising industry, but extend into various multi-billion dollar industries and sub-industries including, but not limited to: apps, online video streaming, online music streaming, and telecommunications. As of 2014, Google currently employs approximately 53,600 full-time employees. Google’s largest search advertising clients of 2014 included Amazon, Priceline Group, AT&T, Expedia, and Microsoft Corp., who collectively contributed to over $450 million worth of Google’s advertising revenues (4). Google also earns revenues from their product and services operations, a growing segment of operations, which constituted 11% of their total revenue structure in 2014 (1). Stock Performance Highlights 52 week High $599.65 52 week Low $487.56 Beta Value 0.93 Average Daily Volume 1,826,450 Share Highlights Market Capitalization $364.52 billion Shares Outstanding 680.2 million P/E Ratio 25.51 Dividend Yield 0% Dividend Payout Ratio N/A Company Performance Highlights ROE 14.52% 2014 Sales $66 billion 2014 Profit Margin 21.2%

Google, Inc. (NASDAQ: GOOG)

April 17, 2015

Current Price $535.53 Target Price $671-$701

Positive Outlook for Google

Over recent years, Google has stabilized its position in its industry’s “multi-screen environment” by both increasing its international operations in developed and emerging markets and heavily investing in research and development. As the number of global internet users increases, Google’s international operations looks promising. We believe that Google will not be able to sustain the exceptionally high YoY growth that it has experienced in recent years, but we are confident that their cash-based investments and expenditures in research and development will add to Google’s shareholder value in the coming year, making them highly desirable. We see revenue growth being driven by pricing improvements in the mobile area and increased traction across a variety of platforms, most notably YouTube, reflecting a more diverse revenue stream. One Year Stock Performance

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Real GDP

The technology sector is extremely sensitive to the

general state of the economy; there is a strong correlation

between the performance of the technology sector and

GDP.i Hence, paying particular attention to this figure

may provide predictive value as to the future of the

sector.

Looking into the latter half of 2015, we believe GDP

growth will reach levels near 2.8% for each of the

remaining quarters. Low oil prices paired with

decreasing unemployment rates will boost consumer

confidence which will increase consumer spending.

With added disposable income and consumer spending

comprising over 2/3rd of GDPii, we believe the economy

will continue expanding, as we enter the 7th year of

expansion this summer. With the predicted increase in

business from confident consumers, companies can

increase discretionary investments into IT services to

ensure their future infrastructures are adequately

prepared to adapt to the constantly evolving business

environment. However, we believe growth will slightly

taper off at the conclusion of the year due to stabilizing

oil prices. We speculate that GDP growth will remain

constant, rising at an annual rate of 3.2% in both 2016

and 2017.

Fixed Investments

Fixed investments, a key component of GDP notes the

IT expenditures made by enterprises. Businesses are

major consumers of technology; as a result, there is a

correlation between the amount of funds companies

invest into tech related services and products and the

relative performance of the technology sector.

Furthermore, the fixed investments data may be

disaggregated into several parts: computers and

peripheral equipment, communication equipment,

medical and instruments, etc. Developing expectations

on future enterprise spending in IT is essential to

understanding where the technology sector is heading.

Since the IT sector is comprised in large part of many

patents, spending on intellectual property is highly

important.

We expect expenditures on intellectual property

products by business enterprises to grow at 3.5% during

2015. For the following two years, we anticipate that

intellectual property will grow at a robust 4.7% rate. A

major stream of business for intellectual property is the

financial sector. Financial institutions spend a

considerate amount on their technological capabilities.

Currently, the financial sector is underperforming but we

anticipate that it will make a recovery in 2016. However,

we anticipate that private spending by companies in

other sectors cam help mitigate the effects of reduced

investments in IT by the financial sector during the first

quarter of 2015. Fixed investments in intellectual

property will grow by 4.7% annually, for the years 2016

and 2017.

Exchange Rates

Exchange rates are an important factor to be

cognizant of since many companies generate substantial sums of revenue abroad. When the

United States dollar is weak relative to foreign

currencies, foreign buyers may perceive goods as absolutely cheap in comparison to the price of goods

when the dollar is strong (and vice-versa).

Additionally, when the dollar is too strong, multinational companies may experience substantial

losses in currency translations. Since many

technology companies conduct business outside of America, taking exchange rates into consideration is

important when evaluating various investment

opportunities.

Economic Outlook

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The graph above shows historical and forecasted values

for the U.S. Dollar Broad Index. Given our research and

the historical trends, we predict by the end of 2015 that

the U.S. Dollar Broad Index level will rise to 113 within

the upcoming six months, and then weaken to 108 the

following year. The Broad Index compares the relative

value of the dollar to a number of other currencies since

1997.iii We believe the U.S. economy will close out the

year strong, while the Europe and other regions of the

world lag behind. Hence, the dollar will finish stronger

at year-end. Conversely, we believe the European

Central Bank’s (ECB) quantitative easing policy that is

likely to be enacted may jumpstart their economy again.

Thus, as Europe and other regions recover economically,

the dollar’s value may diminish slightly. A weakened

dollar in the future translates to cheaper prices for the

overseas market. Therefore, technology companies with

significant operations abroad will be better positioned to

bring back home profits.

Current Employment Statistic

Unemployment is inversely related to GDP growth so

when GDP is low, consumer confidence is low, and

consumers are less likely to purchase discretionary

technology products. Current levels of unemployment,

as of March 31st, 2015, are at 5.5% according to

Bloomberg’s Economic Calendar. During the latter part

of 2015, we believe unemployment will continue the

downward trend to levels of around 5.2%. In the next

few years, we predict the unemployment level will

remain stagnant. Our assumption based upon the current

economic conditions and placement in our expansionary

period is that levels will around 5.0%, as a result of the

increased population entering the labor force and

increased hiring by companies. The Philips Curve,

which represents the correlation between unemployment

and wage inflation, states that lower unemployment

levels lead to higher wages because tighter labor markets

incentive companies that are looking for employees in a

scarce market to offer competitive wages in order to

poach employees and also attract the brightest levels of

talent.

We foresee hours worked, along with wages steadily

increasing over the coming years. Our prediction is that

the average wage will increase 3% this next year. This is

in line with the annual 2.1% increase of the Consumer

Price index for an estimated salary net gain of 0.9% in

2015.

Longer term, we anticipate a recovery in oil prices and a

slower than expected GDP growth, supporting the 1.0%

historical level net salaries have been increasing at. As

we distance ourselves from the great recession and

competition in the labor markets begin to increase, we

expect hours worked to slightly decrease as companies

seek to position themselves as more attractive employers

to job seekers.

Labor force is important to the technology sector

because labor drives businesses. Businesses are either in

the expansionary state and continuously hiring or they

are contracting and laying people off. If the labor force

cannot sufficiently produce enough qualified candidates

to fill vacant roles than companies generally suffer. With

labor force participation rates falling, and no abrupt

changes in sight, the outlook going forward for the

coming months should not greatly alter business. But, in

10 years when a majority of the population age shifts

from the 55-64 age level onto the younger generation we

can expect to see some significant changes in the way

technology companies, and all companies for that

matter, hire employees. The current level of labor force

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participation is at 62.5%. We believe we will continue to

see a steady decline in the labor force participation for

the next 2-3 years due to retiring baby boomers. The

Congressional Budget Office projects that Obamacare

could reduce the labor force by an additional two million

full time workers. At the end of 2013, there were a record

high 11 million people receiving some sort of disability

benefit. Taking into account the previously listed factors,

we expect the labor force rate to fall around 60.0% to

61.0% within the next two to three years.

Capital Markets Outlook

Based on our economic outlook and analysis, we expect

that the stock market will experience moderate growth

throughout 2015. We project that the federal funds rate

will experience a gradual growth of about 0.14%

throughout 2015, eventually causing the stock market to

experience moderate corrections towards the second half

of the year. The growth in the economy will be result of

various economic variables such as Gross Domestic

Product, Inflation, Exchange Rates, and Employment

Levels. Since the technology sector is ultrasensitive to

movements in the economy, we believe that this

projected market growth in 2015 will cause industries in

the technology sector to experience above average

returns.

We predict that the S&P 500 will experience various

minor corrections throughout 2015, but ultimately,

maintain a level around 2,100 points. We do not foresee

any substantial corrections in the market; however, it is

unlikely that the market will maintain the same growth

trends we have seen the past few years.

We decided to focus on a select few industries within the

Technology sector that we believe have the greatest

potential for growth, ROI, and can establish and

maintain economies of scale. The two being: Software,

IT Services, and Internet & Software industries.

Economic drivers, such as GDP growth and the rate

Inflation will play a large role in assisting the growth of

these industries in 2015. Inflation has proven to be a key

driver of the technology industry. Technology firms

monetize on volume, as opposed to monetizing on price,

as a result of most of the sectors’ products being in

perpetual state of deflation. The slowing inflation rates

can be a positive technology sector driver. As inflation

slows, the task of continually establishing economies of

scale and improving production to sustain profit margins

becomes less difficult (Erne, 2010). According to the

bureau of labor statistics, CPI decelerated its growth

from 1.5% throughout 2013 to 0.8% during 2014.iv

According to the recent data posted by the Federal

Reserve on January 30, 2015, GDP had increased at an

annual rate of 2.6%, on average, throughout the year in

2014.v We project oil prices to remain relatively low

throughout the year and unemployment to decline

modestly from 5.6% to 5.2%. We expect that these

events will assist in increasing consumer spending,

resulting in improved GDP numbers. As stated in the

economic outlook, we believe that this GDP trend will

continue to grow at an average rate of 2.8% throughout

2015 (BEA, 2015). Historically, the technology sector

has outperformed the stock market when GDP has risen;

thus, given our GDP predictions we believe the

technology sector will outperform the stock market in

2015.

The technology sector and the financial sector seem to

be highly correlated. Both sectors are highly sensitive to

the fluctuations of capital markets, thus they tend to have

higher betas in comparison to the benchmark

performance of the S&P 500. Historically, the betas for

Technology and Financial sectors have been 1.73 and

1.44, respectively (Erne, 2010). Due to this correlation,

we also foresee the technology sector benefitting from

the financial sector as interest rates increase, leading to

increased revenues for banks and other financial

institutions. These institutions purchase products from

the technology sector and invest in technological firms,

especially in the software and computer service

industries.

We do have one concern with the technology sector.

Technology firms generally pay less in dividends; this

leads to companies retaining a higher portion of

earnings, which are subject to capital gains. Lower rates

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on capital gain taxes could be lucrative for these firms.

However, in the recent State of the Union address on

January 20, 2015, President Barack Obama voiced his

proposal to increase capital gains rate, which is currently

at 20% for the highest-earning Americans, to 28%. If this

law is enacted, it could cause the technology sector to

slowdown.

Industry Description

The “Internet Information Provider” industry is often

referred to as the internet search engine and online advertising Industry. This 12.53 trillion dollar industry

often integrates itself to adapt to the “multi-screen

environment” that today’s technology provides (3). The main driver of this industry is the growing access to

internet on a global scale. From this growth driver, stems

innovations in internet accessible devices, internet availability, internet speed, and products and services

that the internet provides. More individuals are “going

online” either more often or for the first time, mainly as

a result of depreciating computer prices and increased popularity of mobile smartphones. According to

internetlivestats.com, as of July, 1 2014, 2,925,249,355

individuals, or 40.4% of the world’s population are considered “internet users” (4). As of 2014, this

population of internet users is experiencing an annual

growth rate of 7.9%, while the world’s population itself is experiencing an annual growth of 1.14% (4). We

believe that by mid-2015, over 3.4 billion individuals,

will be considered internet users.

Firms in that dominate this industry—such as Google,

Apple, Yahoo, Amazon, Microsoft, and Facebook—that

continually innovate their business models to adapt to

the changes in the internet, succeed in shaping this

industry. Additionally, the reach of these firms’

influence from their operations extends far beyond the

search engine and online advertising industry. New

technological developments, along with innovations in

software, products, and services in this industry, have the

ability to spawn new sub-industries or run other

industries out of business.

Markets and Competition (1)

The search engine industry is extremely concentrated

and the degree of concentration is increasing. In 2009,

the top three companies—Google, Yahoo, and

Microsoft—generated approximately 88% of the industry’s revenue; in 2014, 94.7% of the industry’s

revenue was generated by the top three companies. As a

company’s search results become more useful, the

number of users of a particular search engine increases. When a search engine’s user base increases, more

advertisers are willing to pay to be featured on the site.

The new revenue may be used to improve search results, leading to a larger user base, and thus effectively causing

a cycle.

Search engines compete for both advertisers and users.

The larger the user base, the more willing advertisers are

to pay premiums to particular search engines. Search engines compete for users based off quality of results,

ease of use, speed, and name brand.

Porter’s 5-Forces Threat of new entrants: WEAK due to strong barriers of

entry. Companies competing in this market need highly

specialized IT professionals. The amount of workers

with this skill is scarce when compared to the number of companies seeking their expertise. Additionally, the

brand recognition of the existing search engine

companies thwarts the ability of new entrants to have success in the field.

Threat of substitute services: MODERATE since customers are primarily concerned with the size of a

search engine’s user base. Companies rely on a large

user base to attract advertisers. Switching search engines

is relatively easy for users, and cost the user nothing. Users may only lose convenience to switch. In order to

encourage brand loyalty, search engines provide

additional services such as email, news, online storage, etc. Additionally, search engines are also competing

against other advertising mediums including but not

limited to: television, newspaper, radio, etc.

Industry Analysis

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Power of customers: LOW because advertisers have a

limited selection of search engines to partner with. Furthermore, industry leader Google commands higher

pay-per-click prices as a result of its search query

dominance. As of 2014, Google had 75% of the

industry’s market share, as shown in the graph below. Companies seeking to reach customers through internet

advertisements essentially do not have an option of

partnering with Google (1).

Bargaining power of suppliers: HIGH. Due to most

products and services being generated internally, there aren’t strong forces coming from outside. However,

since software companies are dependent on internal

software engineers to produce and code software, the employees may be classified as suppliers. Demand for

IT professionals greatly outweighs the supply of

workers. Hence, workers command high average salaries ranging from $75,000 to $90,000.

Intensity of Competition: HIGH due to companies

targeting the same users and advertisers. Companies compete on user base, price, and number of partner

websites. In a space where one’s product or services may

become obsolete almost instantly, technology companies are continually striving to innovate and stay

relevant. Search engines must constantly update their

algorithms to ensure users’ needs are met. A happy user base leads to more users and thus translates to increased

marketability for the search engine.

Google is the industry frontrunner—holding a 75.2% of market share for search engines. As of June 2014,

Google had 52,069 employees and recorded revenue for

the year 2014 of $59,056 billion. The graph below outlines the projected growth of the Global Software and

Services industry.

Industry Catalysts for Growth Going Forward

Economic Growth

Economic growth is the single largest driver of the

technology sector. While technology is economically sensitive, there is more to the correlation. Industries can

have vast differences in performance based upon which

stage of the business cycle they’re leveraged too. With

growth beginning to slow, and the Fed looking to raise rates later this year, the future outlook appears bleak. As

expansion turns to contraction, companies may have to

slash spending in areas such as advertising, research and development, and potentially wages. Decreased wage

spending can have serious adverse effects if companies

aren’t able to attract and retain talent.

Economic Drivers

Exchange rates play an important role in the profitability

of US companies. A strong dollar may seem favorable for the US economy, but the numbers tell a different

story. While it is impossible to know for sure where

prices will go in the future, the current rates are unfavorable for American companies competing in

foreign markets. A strong dollar relative to foreign

currencies generally makes products more expensive for

consumers, and in Googles case, it makes advertising more expensive for companies that are seeking to utilize

Googles advertising platform. The euro and the dollar

being comparably even creates an opportunity for future revenue growth in the technology sector. If the euro

begins to recover, disinflation will have a positive effect

on the technology sector.

With inflation being relatively low historically, there

doesn’t seem to be much arbitrage opportunity available

to capitalize on; but on the other end of the spectrum, unanticipated inflation would have a far greater

devastating effect on the economy and the technology

sector than would an anticipated event. And it appears that all of Wall Street is heavily anticipating a Fed rate

hike before the conclusion of 2015.

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Diversification

Core PPI is inversely related to the performance of the

IT sector. Technological equity plays can add diversification to any portfolio. The substitution effect,

which claims that companies will have more money for

discretionary spending as prices fall, suggests an overweight position in technology when YoY PPI falls

below 2.3 percent will enhance the overall portfolio

return.

Industry Outlook

Corporations are allocating larger percentages of advertising budgets to internet advertising as people

spend more time online, especially in comparison to

other media outlets. The growing adaption of smartphones is also a positive for interactive advertising,

and can cultivate traffic and usage. Video advertising is

an emerging opportunity. The ability to monetize mobile

ads and social media will greatly depend upon the ability to tactically utilize video ads on a large scale, as mobile

advertisements reap fewer financial benefits in

comparison to other advertising platforms.

As of 2014 EOY, the global software & services industry

has a value of $2.946 trillion. The expected compounded annual growth rate for the industry from 2014 - 2019 is

4.9%. According to a 4.9% CAGR, the industry will be

worth an estimated $3.748 trillion by 2019, or a 27.2%

increase since 2014. This is portrayed on the graph at the top of the next page.

Cash is King

As of December 31st, 2014, Google had $64.4 billion

dollars in cash, cash equivalents and marketable securities. However, $38.7 billion of the $64.4 billion of

cash is held by their foreign subsidiaries. In order for

Google to obtain these funds for operations within the US, they would be subject to U.S. taxes to repatriate

these funds. The large sum of cash Google possess gives

them some leverage. Google could potentially pay

dividends in the future. If used strategically, the large cash sum allows them swipe up any potential startups

gaining traction, which will help strengthen their core

businesses and continue to develop and explore new opportunities.

Cyber Security Threats

“It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things

differently.” – Warren Buffet.

In relation to the quote above, cyberattacks have the

ability to destroy market share and reputation in a matter

of seconds. Malicious attempts to breach firewalls can adversely affect the customers trust. With less brand

loyalty occurring today than ever it is inherently

important for companies to capitalize and seek to satisfy not only the customers they currently serve, but those

they hope to serve in the future.

Key Investment Positives

Key Investment Negatives

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Investment into New Technology

Something so obvious may often be over looked, but the

inherent risk assumed with investing into researching, developing, innovating, and the expenses and risks

associated with such gambles should not be taken

lightly. Innovation drives the technology industry. The

fear of an insufficient return on capital and inadequate revenues failing to offset the liabilities and expenses

incurred during such endeavors creates an uncertain

future for those companies who cannot stay competitive and innovative.

Intellectual Property Rights

Current regulations protect the financial incentives tied to innovation, which keeps our economy moving

forward. Although, according to the strong form of

market efficiency, financial incentives have already been priced into the current market value. With no signs

of increasing the life individuals are able to hold patents,

there is only a pessimistic outlook on the capitalism tied patent protection. “Intellectual property rights are one of

the most important critical components of capitalism and

properly functioning free markets.” (Fisher

Investments). Any change in the way patents are regulated could discourage the way companies invest in

research and development. Without those added

financial incentives the first mover advantage seems to offer, companies could experience exponential margin

decreases.

Due to current and forecasted micro and macroeconomic factors, recent industry trends, and Google’s

management’s forecasts, we believe that Google will

experience ample revenue growth in 2015. Google has

accomplished everything they need to grow and innovate while maintaining their leading market capitalization in

their central industry. Large research and development

expenditures in addition to acquisitions and new projects in recent years have provided Google with a foundation

for continued growth. Google has also opened several

new channels for revenue streams as a result of newly

initiated programs and side projects.

Production and Distribution

Google develops its own software and hardware

infrastructure. In doing so, Google is provided with substantial computing resources at low cost. Google’s

research and development expenses for segment

increase $687 million from 2012 to 2013 due to an

increase in labor and facilities-related costs of $596 million (7). Google’s substantial investment in

developing their infrastructure has led them to capitalize

on several benefits:

The infrastructure maintenance and design acts as a

relatively fixed cost that can be spread across many

aspects of Google’s cost structure.

This infrastructure, simplifies the storage and

processing of large amounts of data and improves

the operation of large scale, global products and

services.

This infrastructure allows google to apply superior

search and retrieval algorithms that are

computationally complex, saving them money on

hiring additional programmers and coders.

The infrastructure makes the product development

cycle run more efficiently, allowing Google to

innovate in a more cost effective manner.

Google expects to continue to experience growth in their

operations as they build upon their research and

development programs, expand their user base,

advertising clientele, google network members, content providers, and increase their presence in international

markets.

Cost of goods sold for the Google segment increased by

$4.7 billion from 2012 to 2013. According to Googles’

2013 annual report, the increase was due to increases in traffic acquisition costs of $1.3 billion as a result of

increasing distribution fees in addition to more

Executive Summary

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advertiser fees generated through Google’s AdSense

program (7).

Googles’ products and services innovate web search and

advertising techniques to create a competitive

advantage. A significant amount of Google value proposition in their business model rests on their

innovative and proprietary programs AdWords and

AdSense. These programs benefit both user of Google’s

online search engine by accurately and efficiently

retrieving the information they are searching for while promoting the advertising company’s business.

Competition

Google is the top player in their industry for online advertising. The business environment is experiencing

rapid change and convergence. Google faces

competition in every aspect of their business. Primarily this competition stems from companies that seek to

connect people with information on the web and

promote relevant advertising. Online advertising companies, advertising companies, and internet

information providers are the main industries that

compete with Google.

Google’s main competitors include traditional search

engines, such as Yahoo! and Microsoft Corporation’s

Bing, vertical search engines and e-commerce sites (WebMD for health-related queries), Kayak.com (for

travel-related queries), Amazon.com and eBay (for

commerce) (7). The threat to Google is that, although Google may offer some of the services that these

websites provide, users may decide to just navigate

directly to these sites, rather than first going through

Google.

Other competitive industries of Google that may threaten

Google’s main source of revenue (advertising) include traditional forms of advertising, such as television, radio,

magazines, and billboards. We believe that this is less of

a threat than Google’s immediate, website-based

competitors. Google is overcoming this threat by globally establishing itself as an innovative, secure, and

efficient company. Examples of this initiative include

Google’s side projects such as the Google car, the google phone, and google glasses. All of these innovative

projects are widely publicized and benefit Google not

only by the revenue generated, but by the free-advertising and publicity Google receives via word-of-

mouth

As Google’s popularity spreads, we believe that

consumers may subconsciously tend to use Google more than search engine alternatives such as Yahoo!,

Microsoft Bing, or MSN. Recent grand-expenditures on

research and development, will finance Google’s new

facilities, research and development employees, and software and hardware maintenance and innovation.

Comparative Analysis

Currently, Google appears to have the largest market capitalization out of all of its closest competitors and

does not appear to have any weaknesses in its revenue

stream and shareholder satisfaction.

Competitive Environment

Google is competing to attract and retain users of their

search and communication products and services. Most

of the products and services the Google offers its users is “free,” so they are not inclined to compete on price.

We believe that this relieves Google of a great market

pressure, so that Google can instead focus its competitive advantage on the improving relevance and

usefulness of their search results and features, ease of

accessibility, and use of their products and services.

Google’s competitive advantage and mission, as stated

in their annual report is that they are able to provide

high-quality and universal accessibility that makes them effective and profitable when organizing the world’s

information--and do so extremely cost effectively (7).

Google also relies on their patent, trademark, copyrights as well as contractual provisions to protect their

proprietary technology and their brand, this creates a

competitive advantage from them.

Google’s competitive edge is backed by its many

patents, trademarks, copyrights, as well as contractual provisions to protect their proprietary technology and

their brand. These registered trademarks include:

Google, YouTube, AdSense, AdWords, Gmail, I’m

Feeling lucky, blogger, are all registered in the U.S. We believe that all of these trademarks have proven to be

exceptionally lucrative for Google. Today, Educational

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Institutions ranging from grade school to graduate

school use YouTube in professional slide presentations to help explain concepts, in classes to watch

documentaries and interviews, and sometimes for

entertainment purposes. “Google docs” is another

segment of Google’s that is critical in the educational and professional world today. Google’s Brand is one of

the strongest assets it currently possesses. We believe

that in addition to Google’s advertising segments, its software, websites, and programs will continue to grow

in the future.

Overview

Google is an international technology company that

offers advertising, operating systems, enterprise, and

hardware products (11). Google’s headquarter is located

in Mountain View, California. As of December 31, 2014, the company employed 53,600 employees (12).

Google delivers its products and services in over 100

languages, serving over 50 countries (12). Google is primarily in the business of offering search and display

advertising, the Android operating system platform,

consumer content, enterprise, and hardware products

and services. Google was founded by Sergey Brin and Larry Page, two

Stanford graduate students. Initially incorporated in

1998, the company responded to 100,000 searches per

day in its first year. By 1999, the Google’s search feature was utilized approximately 500,000 times a day. Today,

with revenue of $59,825 million for the year ended 2013,

Google is one of the largest technology companies in the world (7). Search and display advertising is the core

business of Google, however, the company offers other

products such as the Android operating system, consumer content, and hardware products.

Government Regulation Since Google is a worldwide website, it is subject to a

number of foreign and domestic laws and regulations

that affect companies conducting business on the internet (7). Possible threats to Google’s business may

encompass any court ruling that imposes liability on

providers of online services for the actions of their users and/or third party affiliates.

Corporate Strategy

In order to optimize profitability, Google focuses on the following:

Serving the users—making products that are user-friendly, quick, and convenient.

Providing advertisers a medium to reach potential

consumers is the core competency of Google. In order to appeal to its customers—advertisers—Google provides

a plethora of products, and strives to be user-friendly.

Bringing the next five billion online—investing in projects that will increase the world’s accessibility to the

internet. Google has projects to assist other areas of the

world gain access to the internet. As previously

mentioned, the larger the user base, the more income Google can generate from advertisers.

Research—Continual development of existing products and services as well as growing new ideas with evidence

to support various projects.

Research and development expenses were 15% of sales.

We believe research and development cost will increase

slightly as a percentage of sales for the forecasted period.

General Information

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Products and Markets

Google products include search, advertising, consumer

content, and enterprise products (6).The companies

search algorithms sort through a plethora of websites and internet content to best answer a user’s search query. The

company also displays related product advertisements to

enhance the users experience by conveniently providing information pertinent to queries.

Google’s advertising business is primarily auction-

based. Google enables companies to advertise when

relevant searches are queried. Advertisers typically pay on a per-click basis—charged each time a user clicks on

the advertisement. Conversely, some advertisers select

the cost-per-impression option—charged for how frequently the advertisement is displayed.

Major Products (6)

AdSense

AdWords

YouTube

“Google Play”

“Nexus” Devices

“Google for Work”

Google Networks

As exhibited in the chart above, Google’s revenue-per-click has been declining drastically over the past few

years. Last year, revenue-per-click decreased by 5%. We

anticipate this trend will continue. Conversely, we

predict that the benefit from additional paid clicks will outweigh the lost revenues. In the previous year, Google

had an aggregate increase of 20%.

The company’s consumer content business includes

Android and Google+. Android, which is comprised of

over 75 mobile-phone, technology companies, is a platform to create applications for mobile-phones,

iPhones, tablets, etc. (6). Google+ is a social medium

with approximately 540 million users as of October

2013. Additionally, Google offers: Google Play, a digital entertainment store for applications, music, movies, etc.;

Google Chrome, a web-browser; Chromebook

computers and Chromecast products.

Google enterprise solutions provides enhanced versions

of common google products, such as Gmail, Drive,

Calendar, etc., to fit unique requirements of businesses.

Motorola mobile

Google formerly maintained a mobile-device business

segment, selling hardware and related services. In 2014,

Google sold the Motorola mobile segment to Lenova for approximately $2.9 billion (7).

We believe the divesture was a good move. The mobile-phone market exhibits extreme competition and the

segment was not aligned with the core business strategy

of the company. Although, Google purchased Motorola for significantly more a couple years prior, the sale was

not completely terrible as a result of Google maintaining

the rights to many of Motorola’s patents.

Google’s Catalysts for Growth & Change

Emerging Markets and Increased Globalization As the third world countries begin to develop, we will

see mass adaption of the technologies used across

mature economies. One of these technologies used

across multiple platforms, countries, and continents is google search. Google is the leading search engine

worldwide and continues to develop and improve as

more information becomes readily accessible with each passing day.

Market Share

Google has a dominant portion of the search engine

industry, and this only appears to be growing with time.

The innovation and continuous improvements make it highly probable that Google will continue to dominant

the search engine industry for a long time to come.

Google makes a majority of their revenue through advertising. There is a lot to be said for a company with

a $368B market cap that made roughly 91% of their

revenue from one area; that area being advertising. On

the other hand, with low overhead costs and extremely high profit margins, it is no surprise that they should

milk every last dollar from what they are established and

dominant at. We believe google will continue to profit but not at the margins they are seeing today. Increased

traffic leads to increased costs, such as server farms, data

warehousing, data mining, and hiring the talent to

[AUTHOR NAME] 12

manage and build this all can be quite costly. But, if

Google continues to grow and manage their billions of dollars of cash appropriately, utilizing stock buyback

programs and making investments for the future, they

will remain profitable and sustainable in the long run.

Currencies and Trade Policy

The strengthening of the US dollar compared to the

Euro, Yen and British Pound negatively impacts

Google’s revenues. Google will continue to make investments into foreign markets, but it may not see an

increase in international revenue as a percentage of total

revenues. Trade policy also plays an important factor in

the accommodativeness and or restrictiveness of specific products being traded. Laws can provide an unfair

advantage to some industries and disadvantages to

others. We believe trade policies will continue to have a sizeable effect on the overall sector performance.

SWOT Analysis

Strengths

Google is an industry leader when it comes to searching the internet for any information that comes to mind.

What sets Google apart in terms of search engines is

their trade mark algorithms that return search results faster than any other competitor with a higher degree of

relevancy and accuracy. With an attractive website that

sees over 3.5 billion searches a day (15), capitalizing on

the opportunity to advertise via google is something that many companies seek to do because of the exposure they

can potentially get. The graph below shows how the

annual searches on google have increased exponentially the past 10 years.

Weaknesses

With 55% of Googles revenue in 2013 coming from

international markets and the strengthening of the US

dollar compared to the Pound, Yen and Euro, we expect

to see their revenues underperform relative to the consensus in 2015. The exposure to currency risk is one

that can be managed and hedged against with currency

futures contracts. Having this sort of insurance will minimize the potential decline in revenues due to the

markets natural roller coaster motion, but their size

doesn’t necessarily make them expert hedgers. Something that always seems to haunt very large

organizations are legal fees. We expect to see continued

spending related to new offerings and government

inquires/investigations, including the European Commission announced this month. Another weakness

Google faces is their declining profit margin, as denoted

by the graph below.

Opportunities

One major opportunity that lies ahead for Google is the increased smartphone usage across countries. Google

will continue to gain traction in the mobile search

industry and will continue to capitalize as the global

economy becomes more interdependent and reliant upon cutting edge technology. Another opportunity is the

ability to implement, utilize and profit from video ads,

via YouTube, mobile phones, and new users coming online for the first time.

[AUTHOR NAME] 13

Threats

A threat that is always lurking around companies,

especially companies that function primarily over the

internet are cyberattacks. If google were to experience a

hack and sensitive information fell into the wrong hands than it is highly probable that customers, and the general

population may have a shift in opinion towards Google’s

storing of mass amounts of data in their data warehouses. This could also tarnish their reputation and brand name

which would affect future business, such as BP with the

Gulf oil spill. The loitering problems of a potential market share loss, excess expansion costs, and adverse

legal developments could all adversely impact Googles

revenues.

Revenue Decomposition

As Google’s 2014 annual report indicates, Google’s total

revenue is divided into two segments: advertising

revenues and “other” or “non-advertising” revenues.

Advertising revenues is comprised of both revenues generated from Google’s Websites and revenues

generated from Google’s Network Members’ websites.

In the fiscal year ended 2014, advertising revenues

constituted 89% of Google’s total revenues, leaving non-

advertising revenues to represent 11% of their total sales.

Historically, Google’s revenue structure has been heavily weighted on their advertising sales, which have

averaged about 93% of total sales over the course of the

past five years. Recently, however, Google’s revenues from non-advertising operations have begun to increase

as a percentage of total sales. Non-advertising revenues

as a percentage of total sales increased from 4% in 2011, to 5% in 2012, 9% in 2013, up to almost 11% in 2014

(1). This change in revenue structure can be attributed to

both Google’s initiative to improve their products and

services to adapt to the world’s “multi-screen environment” and also to Google’s international sales.

Critical Assumptions

Costs of Goods Sold

Since historical cost of goods sold expenses in direct

relation to total revenues has remained fairly constant,

we calculated Google’s cost of goods sold expense at a

constant rate of 35% of forecasted revenues.

Selling, General, and Administrative Expense

Google’s selling, general, and administrative expenses

are composed of research and development expenses and

“other SG&A” expenses. In order to accurately forecast total SG&A expense, we forecasted the two sections of

Googles SG&A separately. Google’s Research and

Development expenses as a percentage of total sales has continually increased from 6% in 2010 to 34% in 2014.

We believe that Google is heavily investing in research

and development in order to improve their search and advertising operations and improve their products and

services such as Google Play, Google for Work, and

“Nexus” devices. These products and services provide

software video games and apps, online music, online videos, and other trends that are currently driving this

industry. In doings so, Google can better compete

against its top competitors: Apple, Amazon, and Yahoo. Using this rationale, we forecasted Google’s Research

and Development Expenses to be as 15% of forecasted

revenues in the short term, 16% in the midterm, and 15.5% in the long term. Based on average historical

“Other SG&A” expenses as percentage of total

revenues, we forecasted that “Other SG&A” expenses

will grow at a constant rate of 23% of forecasted revenues.

Amortization

We used a common sized income statement for Google

and determined the average of historical amortization

expenses as percentages of historical total revenues. We got that, on average, Google’s amortization expense has

been 20% of total sales. We believe that Google’s

Amortization expenses will increase in the future as a result of

Goodwill

Our group believes that attempting to forecast any

company’s future net goodwill payments is extremely

difficult and seldom free of error. Therefore, in order to provide our most accurate valuation of Google, we set

Google’s Goodwill to a constant value throughout our

forecasted period. That value is $15,599 million, which is the net, goodwill value on Google’s 2014 balance

sheet.

Share Buybacks

Google has had no history of Treasury stock in the past

five fiscal years, and therefore no history of repurchasing

Valuation Discussion

[AUTHOR NAME] 14

shares of stock. Our assumption for the forecasted

period, is that Google will continue not to participate in share buybacks; however, since they have never

historically bought back shares, any future plan to buy

back shares could have a vastly positive impact on the

underlying stock price.

WACC

Cost of Equity

We utilized the Capital Asset Pricing Model (CAPM) to calculate the required rate of return on equity for Google.

We used the current rate of return on a 30-year U.S.

Treasury bond for the risk-free rate. This rate was 2.51%

as of April 2, 2015. For the market risk premium, we used 5.0%, which is the geometric average market risk

premium of our valuation’s performance benchmark, the

S&P 500, from 1928 to 2014. Finally we calculated Google’s beta by using a Bloomberg terminal to track

their five year historical beta on five different days,

receiving an average beta of 0.93. Plugging in all of the CAPM inputs gave us a cost of equity equal to 7.16%

Cost of Debt

Ideally, we would have calculated Google’s cost of debt

by simply finding the require rate of return on debt for a

Google 30-year corporate bond. Unfortunately, Google only issues 10-year corporate bonds. We decided to

calculate the cost of debt by researching Google’s bond

credit rating and using the required rate of return on debt

of a similar credit-rated company’s long-term corporate bond. Google’s S&P 500 bond credit rating is AA, so

since Apple is rated AA, we used a 30-year Apple

corporate bond. The pre-tax cost of debt on this bond was 3.71%. We then calculated the after-tax cost of debt,

to be used in the WACC calculation, by multiplying the

pre-tax cost of debt by one minus Googles marginal tax rate of 38.5%. This calculation gave us an after-tax cost

of debt of 2.78%

Weight of Equity

Our group first calculated the market value of equity by

multiplying the amount of shares outstanding by the current stock price as of April 2, 2015. Then we divided

the Market value of total equity by the market value of

the firm’s total capital which is the sum of the firm’s market value of equity and market value of debt.

Weight of Debt

Our group first computed Google’s market value of total

debt. This included Google’s short-term debt, long-term debt, current-portion of long term debt, and the present

value of the minimum payments of Google’s current

operating leases. This value was then divided by the

market value of the firm’s total capital which is the sum of the firm’s market value of equity and market value of

debt.

*Google had no preferred stock outstanding in 2014.

DCF & EP

When using both the discounted cash flow and economic

profit models, our group computed Google’s (GOOG)

intrinsic stock price to be $676.48 per share. While using the discounted cash flow method, we chose to use a

forecast horizon of 8 years into the future. We believe

that this forecast horizon will provide an accurate estimate of Google’s future stock price, after taking into

account current and forecasted market trends, forecasted

micro and macroeconomic events, and Google’s management’s discussion of future acquisitions, capital

expenditures, productivity, and growth.

After 2022, we forecast that Google will grow at continuing value rate of 3.20%. We estimated their

growth to slow down because of the oversaturated

technology market. Also, Google having roughly an 80% global market share in the search industry, it will

become increasingly harder to seize market share.

Our calculated intrinsic price for Google’s stock of $682.76 is fairly higher than Google’s current stock

price of $535.53, as of April 17, 2015. This reflects a

we believe that our DCF price accurately reflects the value of Google’s operations after accounting for

various values of non-operating assets and values of debt

that Google experienced in 2014. This represents a 27.5% price increase. We see essentially unlimited

upside, with little downside.

Several of Google’s actions in the past fiscal year have signaled that they forecast an increase in the growth rate

of their revenues. One signal that Google may be

undervalued, is that in the “Management’s Discussion and Analysis of Financial Condition” section of

Google’s 2014 annual report, management noted that

they expect to continue spend cash on acquisitions and other investments, instead of using Google stock to

finance expenditures. This indicates that their stock has

greater value to them than cash.

[AUTHOR NAME] 15

DDM

Google has no history of paying out dividends, therefore

it has a historical dividend payout ratio equal to zero.

Since we couldn’t use the traditional dividend discount

model to compute the intrinsic price per share of Google stock, we used a “theoretical dividend discount model.”

To do this, we calculated Google’s theoretical dividend

payout ratio by subtracting the retention ratio from earnings from one. We calculated the retention ratio by

dividing the estimated continuing value of revenue

growth percentage by the estimated, continuing value of return on equity percentage. After calculating the sum

of the present value of Google’s theoretical dividends

throughout the forecast period, we discounted the

dividends by the return on equity discount rate. This gave us an intrinsic stock price of $762.02. Our last step

was that we adjusted the intrinsic stock price for the

partial year elapsed. This gave us a final, adjusted target stock price for Google of $777.63.

Sensitivity Analysis

Pre-Tax Cost of Debt vs Cost of Equity

Using a Pre-tax cost of debt of 3.71% and a 7.16% cost of equity to examine the WACC sensitivity allows us to

simultaneously evaluate the impact that movements in

both the fixed income and the equity markets have. As our analysis concludes, fluctuations in the cost of debt

do not vastly effect the WACC.

Beta vs Equity Risk Premium

Running this sensitivity analysis allowed us to test the

GOOG’s intrinsic stock price sensitivity to the natural fluctuations of the market both internationally and

domestically. Higher risk premiums lead to a lower stock

price, which is more likely to happen in expansionary periods, given the inflated returns investors obtain

during times of economic prosperity.

SG&A vs COGS as % of Sales

This regression allowed us to forecast what could

potentially happen if Google were to increase COGS. We see the declining labor force increasing wages, thus

increasing COGS. Also, as Google enters foreign

markets and continues to gain traffic on websites they will need to increase spending on high cap ex items such

as data warehouses, new engineers & other employees,

just to name a few.

[AUTHOR NAME] 16

Sources

(1) Google, Inc. (2014). Form 10-K 2014. Retrieved

from website

http://investor.google.com/financial/filings-

archives.html.

(2) MarketLine "The University of Iowa

Libraries." Proxy Login -. Web. 11 Feb. 2015.

(3) Erne, B., Teufel, A. (2010). Fisher Investments on

Technology (pp. 43-65). Hoboken, N.J: John Wiley

& Sons. February 1, 2015.

(4) National Data." U.S. Bureau of Economic Analysis

(BEA). N.p., n.d. Web. 04 Feb. 2015. (5) Trade-Weighted Dollar Definition |

Investopedia." Investopedia. N.p., 24 Nov. 2003.

Web. 04 Feb, 2015.

(6) Crawford, M., Church J., Akin B. (2014) U.S.

Bureau of Labor Statistics, “BLS CPI Detailed

Report (PDF),” CPI Tables, website

http://www.bls.gov/cpi/tables.htm, February 4,

2015. (7) U.S. Bureau of Economic Analysis, “Gross

Domestic Product: Fourth Quarter and Annual

2014.

(8) Kessler, S. “Computers: Commercial Services.”

S&P Capital IQ Industry Surveys, January 2015.

NetAdvantage. Web. February 10, 2015.

(9) Diment, Dmitry. IBISWorld Industry Report

51821.IBISWorld, 2015. Web. 5 Feb.2015.

(10) Mergentonline. Mergent, 2015. Web. Feb 5,

2015.

(11) Erne, B., Teufel, A. (2010). Fisher Investments

on Technology (pp. 69-97). Hoboken, N.J: John

Wiley & Sons. Feb 7, 2015.

(12) Search Engine Industry: Competitive

Landscape. IBISWorld, 2015. Web. 25 March

2015.

(13) "Google Inc." Yahoo! Finance. Web. 14 Apr.

2015.

(14) "Google Search Statistics." - Internet Live

Stats. 2015. Web. 14 Apr. 2015.

Important Disclaimer

This report was created by students enrolled in the Security Analysis (6F:112) class at the University of Iowa. The report

was originally created to offer an internal investment

recommendation for the University of Iowa Krause Fund and

its advisory board. The report also provides potential

employers and other interested parties an example of the

students’ skills, knowledge and abilities. Members of the

Krause Fund are not registered investment advisors, brokers

or officially licensed financial professionals. The investment

advice contained in this report does not represent an offer or

solicitation to buy or sell any of the securities mentioned.

Unless otherwise noted, facts and figures included in this report are from publicly available sources. This report is not a

complete compilation of data, and its accuracy is not

guaranteed. From time to time, the University of Iowa, its

faculty, staff, students, or the Krause Fund may hold a

financial interest in the companies mentioned in this report.

Weighted Average Cost of Capital (WACC) Estimation

Market Value of Debt 10,298

LT Debt 3,228

ST Debt & Current Portion of LT debt 2,009 Cost of Debt After-Tax Cost of Debt

PV of Operating Leases 5,061 3.71%

Pre-tax Cost of Debt 3.71% x 2.78%

Marginal Tax Rate 25.00% 1-Tax Rate X

After-Tax Cost of Debt 2.78% 75.0% Weight of Debt 0.08%

Average Weight of Debt 2.75% 2.7%

+ WACC

Market Value of Equity 364,253 7.04%

Risk-Free Rate 2.51% Risk-Free Rate Weight of Equity

Marekt Risk Premium 5.00% 2.51% 97.3%

Beta 93.00% + X 6.96%

Cost of Equity 7.16% Beta Cost of Equity

Average Weight of Equity 97.25% 0.93 7.16%

x

Market Value of Preferred Stock 0 Equity Risk Premium

Cost of Preferred Stock 0 5.00%

Market Value of Firm 374,551

WACC 7.04%

Weighted

Cost of

Debt

Weighted

Cost of

Equity

Google

Revenue Decomposition

Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E CV

Advertising Revenues:

Google Websites 31,221 37,422 45,085 51,848 59,625 66,780 74,793 83,769 92,146 101,360 105,617

Google Network Members' websites 12,465 13,125 13,971 16,067 18,477 20,694 23,177 25,958 28,554 31,410 32,729

Total Advertising Revenues 43,686 50,547 59,056 67,914 78,102 87,474 97,971 109,727 120,700 132,770 138,346

Other Revenues 2,353 4,972 6,945 7,987 9,185 10,287 11,521 12,904 14,194 15,614 16,270

Total Googe Revenues 46,039 55,519 66,001 75,901 87,286 97,761 109,492 122,631 134,894 148,384 154,616

Motorola Mobile:

Total Motoral Mobile revenues 4,136 4,306 5,486

Total Revenues 50,175 59,825 71,487 75,901 87,286 97,761 109,492 122,631 134,894 148,384 154,616

Advertising Revenues:

Google Websites 68% 67% 68% 68% 68% 68% 68% 68% 68% 68% 68%

Google Network Members' websites 27% 24% 21% 21% 21% 21% 21% 21% 21% 21% 21%

Total Advertising Revenues 95% 91% 89% 89% 89% 89% 89% 89% 89% 89% 89%

Other Revenues 5% 9% 10.52% 10.52% 10.52% 10.52% 10.52% 10.52% 10.52% 10.52% 10.52%

Total Googe Revenues 100% 100% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Google

Income Statement

(In millions )

Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

Sales 49,958 59,730 65,830 75,901 87,286 97,761 109,492 122,631 134,894 148,384 154,616

COGS excluding D&A 17,543 21,885 7,215 26,565 30,550 34,216 38,322 42,921 47,213 51,934 54,115

Depreciation 1,988 2,781 3,523 5,135 5,875 6,756 7,567 8,475 9,492 10,441 11,485

Amortization of Intangibles 974 1,158 1,078 1,152 864 648 583 408 286 200 163

Gross Income 29,453 33,906 54,014 43,049 49,998 56,141 63,020 70,827 77,904 85,808 88,852

SG&A Expense

Research & Development 6,593 7,910 9,832 11,385 13,093 14,664 16,424 19,621 21,583 23,741 23,965

Other SG&A 9,741 12,002 13,982 17,078 19,639 21,996 24,636 27,592 30,351 33,386 34,789

EBIT (Operating Income) 13,119 13,994 30,200 14,586 17,265 19,480 21,961 23,614 25,970 28,681 30,098

Nonoperating Income - Net 791 500 1,089 1,100 1,125 1,150 1,176 1,202 1,229 1,257 1,285

Other Income (Expense) 78 (285) 343

Interest Expense 84 83 111 573 615 701 793 884 990 1,097 1,203

Unusual Expense - Net 440 (85) 13,919 - - - - - - - -

Pretax Income 13,386 14,496 17,259 12,913 15,525 17,629 19,992 21,528 23,751 26,327 27,610

Income Taxes 2,598 2,282 3,331 4,175 4,801 5,377 6,022 7,358 8,094 8,903 10,050

Consolidated Net Income 10,788 12,214 13,928 8,739 10,725 12,252 13,969 14,170 15,657 17,424 17,560

Net Income 10,788 12,214 13,928 8,739 10,725 12,252 13,969 14,170 15,657 17,424 17,560

EPS (recurring) 16.71 17.95 34.45 25.87 31.50 35.89 40.82 41.31 45.53 50.55 50.82

Total Shares Outstanding 659.11 671.02 680.17 682 684 685 687 689 690 692 694

Dividends/Share $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00

Google

Balance Sheet (In Millions)

Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

Balance Sheet

Assets - - - - - - - -

Cash and Cash Equivalents 14,778 18,898 18,347 24,161 31,950 41,825 52,520 62,998 75,451 88,751 114,112

Marketable Securities (Short-term investments) 33,310 39,819 46,048 47,079 48,134 49,212 50,315 51,442 52,594 53,772 54,977

Accounts Receivable, Net 8,585 9,390 11,556 13,283 15,275 17,108 19,161 21,460 23,606 25,967 25,512

Inventories 505 426 - 425 489 547 613 687 755 831 866

Other Current Assets 3,276 4,353 4,734 5,503 6,328 7,088 7,938 8,891 9,780 10,758 11,210

Total Current Assets 60,454 72,886 80,685 90,451 102,176 115,781 130,547 145,477 162,187 180,079 206,676

Net Property, Plant & Equipment 11,854 16,524 23,883 27,324 31,423 35,194 39,417 44,147 48,562 53,418 49,477

Total Investments and Advances 1,469 1,976 3,079 3,148 3,218 3,291 3,364 3,440 3,517 3,595 3,676

Long-Term Note Receivable - - 1,325 - - - - - - - -

Net Goodwill 10,537 11,492 15,599 15,599 15,599 15,599 15,599 15,599 15,599 15,599 15,599

Net Other Intangibles 7,473 6,066 4,607 3,455 2,591 1,944 1,361 952 667 467 303

Deferred Tax Assets - - - 215 247 276 310 378 416 458 517

Other Assets 2,011 1,976 1,955 2,002 2,051 2,100 2,151 2,203 2,257 2,311 2,367

Total Assets 93,798 110,920 131,133 142,194 157,306 174,185 192,749 212,197 233,203 255,927 278,615

Liabilities & Shareholders' Equity

ST Debt & Curr. Portion LT Debt 2,549 3,009 2,009 461 493 528 565 604 647 692 740

Accounts Payable 2,012 2,453 1,715 1,973 2,269 2,542 2,847 3,188 3,507 3,858 4,020

Income Taxes Payable 240 24 96 125 144 161 211 258 283 312 402

Other Current Liabilities 9,536 10,422 12,985 16,162 18,634 21,430 24,001 26,881 30,107 33,118 36,430

Total Current Liabilities 14,337 15,908 16,805 18,722 21,541 24,661 27,624 30,932 34,544 37,979 41,592

Long-Term Debt 2,988 2,236 3,228 3,454 3,696 3,954 4,231 4,527 4,844 5,183 5,546

Deferred Tax Liabilities 1,872 1,947 1,971 1,362 1,566 1,754 1,965 2,401 2,641 2,905 3,279

Other Liabilities (excl. Deferred Income) 2,786 3,381 4,525 4,934 5,674 6,354 7,117 7,971 8,768 9,645 10,050

Deferred Income 100 139 104 121 140 156 175 196 216 237 247

Total Liabilities 22,083 23,611 26,633 28,593 32,617 36,880 41,112 46,027 51,014 55,950 60,715

Common Stock 22,835 25,922 28,767 29,130 29,493 29,856 30,219 30,582 30,945 31,308 31,671

Retained Earnings 48,342 61,262 75,706 84,445 95,169 107,421 121,391 135,561 151,218 168,642 186,202

Cumulative Translation Adjustment/Unrealized For. Exch. Gain (66) 75 (394) (394) (394) (394) (394) (394) (394) (394) (394)

Unrealized Gain/Loss Marketable Securities 604 50 421 421 421 421 421 421 421 421 421

Total Equity 71,715 87,309 104,500 113,602 124,689 137,304 151,637 166,170 182,190 199,977 217,900

Total Liabilities & Shareholders' Equity 93,798 110,920 131,133 142,194 157,306 174,185 192,749 212,197 233,203 255,927 278,615

Google

Historical Cash Flow Statement

(In Millions)

Fiscal Years Ending Dec. 31 2009 2010 2011 2012 2013 2014

Cash Flow

Operating Activities

Net Income / Starting Line 6,520 8,505 9,737 10,737 12,920 14,444

Depreciation and Depletion 1,240 1,067 1,396 1,988 2,781 3,523

Amortization of Intangible Assets 284 329 455 974 1,158 1,078

Deferred Taxes & Investment Tax Credit (268) 9 343 (266) (437) (104)

Other Funds 1,054 1,270 2,004 2,288 2,268 3,071

Receivables (504) (1,129) (1,156) (787) (1,307) (1,641)

Inventories -- -- -- 301 (234) --

Accounts Payable 34 272 101 (499) 605 436

Income Taxes Payable -- -- -- 1,492 401 --

Other Accruals 243 745 795 762 967 1,002

Other Assets/Liabilities 713 13 890 (371) (463) 567

Net Operating Cash Flow 9,316 11,081 14,565 16,619 18,659 22,376

Investing Activities

Capital Expenditures (810) (4,018) (3,438) (3,273) (7,358) (10,959)

Net Assets from Acquisitions (108) (1,067) (1,900) (10,568) (1,448) --

Sale of Fixed Assets & Businesses -- -- -- -- 2,525 386

Purchase/Sale of Investments (7,101) (7,956) (13,349) 1,119 (7,699) (6,997)

Other Funds - 2,361 (354) (334) 301 (3,485)

Net Investing Cash Flow (8,019) (10,680) (19,041) (13,056) (13,679) (21,055)

Financing Activities

Change in Capital Stock - (801) - - - -

Issuance/Reduction of Debt, Net - 3,463 726 1,328 (557) (18)

Other Funds 233 388 81 (99) (300) (1,421)

Net Financing Cash Flow 233 3,050 807 1,229 (857) (1,439)

Net Change in Cash 1,530 3,451 (3,669) 4,792 4,123 (118)

Beginning Balance 8,656 10,198 13,630 9,983 14,778 18,898

Ending Balance 10,198 13,630 9,983 14,778 18,898 18,347

1,542 3,432 (3,647) 4,795 4,120 (551)

GoogleProjected Cash Flow Statement(In Millions)Fiscal Years Ending Dec. 31 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

Cash FlowOperating ActivitiesNet Income / Starting Line 8,739 10,725 12,252 13,969 14,170 15,657 17,424 17,560 Add: Depreciation and Depletion 5,135 5,875 6,756 7,567 8,475 9,492 10,441 11,485 Add: Amortization of Intangible Assets 1,152 864 648 583 408 286 200 163 Deferred Taxes (823) 172 158 177 367 202 222 315 Other Funds (marketable securities) (1,031) (1,055) (1,078) (1,102) (1,127) (1,152) (1,178) (1,204) Receivables (1,727) (1,992) (1,833) (2,053) (2,299) (2,146) (2,361) 456 Inventories (425) (64) (59) (66) (74) (69) (76) (35) Other Current Assets (769) (825) (759) (851) (953) (889) (978) (452) Accounts Payable 258 296 272 305 342 319 351 162 Income Taxes Payable 29 19 17 49 47 26 28 90 Other Current Liabilities 3,177 2,473 2,795 2,572 2,880 3,226 3,011 3,312 Deferred Income 17 18 17 19 21 20 22 10 Other Liabilities 409 740 681 763 854 797 877 405 Net Operating Cash Flow 14,140 17,245 19,867 21,932 23,111 25,768 27,983 32,267

Investing ActivitiesCapital Expenditures (8,576) (9,973) (10,527) (11,790) (13,205) (13,906) (15,297) (7,544) Other Assets (47) (48) (50) (51) (52) (53) (55) (56) Gross Intangibles - - - - - - - - Note Receivable 1,325 - - - - - - - Purchase/Sale of Investments (69) (71) (72) (74) (75) (77) (79) (81) Net Investing Cash Flow (7,368) (10,092) (10,648) (11,914) (13,332) (14,037) (15,430) (7,680)

Financing ActivitiesChange in Capital Stock 363 363 363 363 363 363 363 363 Issuance/Reduction of Debt, Net (1,322) 274 293 314 336 359 384 411 Other FundsNet Financing Cash Flow (959) 637 656 677 699 722 747 774

Net Change in Cash 5,814 7,789 9,875 10,695 10,478 12,453 13,300 25,361 Beginning Balance 18,347 24,161 31,950 41,825 52,520 62,998 75,451 88,751 Ending Balance 24,161 31,950 41,825 52,520 62,998 75,451 88,751 114,112

Google

Common Size Balance Sheet

Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

Balance Sheet

Assets

Cash and Cash Equivalents 29.58% 31.64% 27.87% 31.83% 36.60% 42.78% 47.97% 51.37% 55.93% 59.81% 73.80%

Marketable Securities (Short Term Investments) 66.68% 66.66% 69.95% 62.03% 55.15% 50.34% 45.95% 41.95% 38.99% 36.24% 35.56%

Short-Term Receivables, Net 17.18% 15.72% 17.55% 17.50% 17.50% 17.50% 17.50% 17.50% 17.50% 17.50% 16.50%

Inventories 1.01% 0.71% 0.00% 0.56% 0.56% 0.56% 0.56% 0.56% 0.56% 0.56% 0.56%

Other Current Assets 6.56% 7.29% 7.19% 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% 7.25% 7.25%

Total Current Assets 121.01% 122.03% 122.57% 119.17% 117.06% 118.43% 119.23% 118.63% 120.23% 121.36% 133.67%

Net Property, Plant & Equipment 23.73% 27.66% 36.28% 36.00% 36.00% 36.00% 36.00% 36.00% 36.00% 36.00% 32.00%

Gross Property, Plant & Equipment 35.42% 39.91% 49.74% 54.44% 58.77% 63.24% 67.23% 70.80% 74.67% 78.19% 79.92%

Accumulated Depreciation 11.70% 12.24% 13.46% 18.44% 22.77% 27.24% 31.23% 34.80% 38.67% 42.19% 47.92%

Total Investments and Advances 2.94% 3.31% 4.68% 4.15% 3.69% 3.37% 3.07% 2.80% 2.61% 2.42% 2.38%

Long-Term Note Receivable 0.00% 0.00% 2.01% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 2.01% 0.00%

Net Goodwill 9.69% 8.10% 7.35% 6.38% 5.54% 4.95% 4.42% 3.95% 3.59% 3.26% 3.13%

Net Other Intangibles 2.00% 1.67% 1.51% 1.31% 1.14% 1.02% 0.91% 0.81% 0.74% 0.67% 0.64%

Deferred Tax Assets 0.00% 0.00% 0.00% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14% 5.14%

Other Assets 4.03% 3.31% 2.97% 2.64% 2.35% 2.15% 1.96% 1.80% 1.67% 1.56% 1.53%

Total Assets 187.75% 185.70% 199.20% 174.78% 170.92% 171.06% 170.74% 169.13% 169.98% 172.42% 178.49%

Liabilities & Shareholders' Equity

ST Debt & Curr. Portion LT Debt 5.10% 5.04% 3.05% 0.61% 0.57% 0.54% 0.52% 0.49% 0.48% 0.47% 0.48%

Accounts Payable 4.03% 4.11% 2.61% 2.60% 2.60% 2.60% 2.60% 2.60% 2.60% 2.60% 2.60%

Income Taxes Payable (As a % of income tax expense) 9.24% 1.05% 2.88% 3.00% 3.00% 3.00% 3.50% 3.50% 3.50% 3.50% 4.00%

Other Current Liabilities 19.09% 17.45% 19.73% 21.29% 21.35% 21.92% 21.92% 21.92% 22.32% 22.32% 23.56%

Total Current Liabilities 28.70% 26.63% 25.53% 27.50% 27.51% 28.06% 28.54% 28.51% 28.90% 28.89% 30.64%

Long-Term Debt (As a % of beginning Non-cash assets) 10.69% 4.89% 6.18% 5.18% 5.21% 5.12% 5.09% 5.04% 4.96% 4.93% 4.89%

Deferred Tax Liabilities 72.06% 85.32% 59.17% 32.63% 32.63% 32.63% 32.63% 32.63% 32.63% 32.63% 32.63%

Other Liabilities (excl. Deferred Income) 5.58% 5.66% 6.87% 6.50% 6.50% 6.50% 6.50% 6.50% 6.50% 6.50% 6.50%

Deferred Income 0.20% 0.23% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16% 0.16%

Total Liabilities 44.20% 39.53% 40.46% 71.97% 72.01% 72.47% 72.92% 72.84% 73.14% 73.10% 74.82%

Common Stock 45.71% 43.40% 43.70% 38.38% 33.79% 30.54% 27.60% 24.94% 22.94% 21.10% 20.48%

Retained Earnings 96.77% 102.56% 115.00% 111.26% 109.03% 109.88% 110.87% 110.54% 112.10% 113.65% 120.43%

Cumulative Translation Adjustment/Unrealized For. Exch. Gain -0.13% 0.13% -0.60% -0.52% -0.45% -0.40% -0.36% -0.32% -0.29% -0.27% -0.25%

Unrealized Gain/Loss Marketable Securities 1.21% 0.08% 0.64% 0.55% 0.48% 0.43% 0.38% 0.34% 0.31% 0.28% 0.27%

Total Equity 143.55% 146.17% 158.74% 149.67% 142.85% 140.45% 138.49% 135.50% 135.06% 134.77% 140.93%

Total Liabilities & Shareholders' Equity 187.75% 185.70% 199.20% 99.47% 99.53% 100.53% 101.45% 101.35% 102.04% 101.99% 105.46%

Google

Common Size Income Statement

Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

COGS excluding D&A 35.12% 36.64% 10.96% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00% 35.00%

Depreciation (As a % of Sales) 3.98% 4.66% 5.35% 6.77% 6.73% 6.91% 6.91% 6.91% 7.04% 7.04% 7.43%

Amortization of Intangibles (As a % of Sales) 1.95% 1.94% 1.64% 1.52% 0.99% 0.66% 0.53% 0.33% 0.21% 0.13% 0.11%

Gross Income 58.96% 56.77% 82.05% 56.72% 57.28% 57.43% 57.56% 57.76% 57.75% 57.83% 57.47%

Research & Development 13.20% 13.24% 14.94% 15.00% 15.00% 15.00% 15.00% 16.00% 16.00% 16.00% 15.50%

Other SG&A 19.50% 20.09% 21.24% 22.50% 22.50% 22.50% 22.50% 22.50% 22.50% 22.50% 22.50%

EBIT (Operating Income) 26.26% 23.43% 45.88% 19.22% 19.78% 19.93% 20.06% 19.26% 19.25% 19.33% 19.47%

Nonoperating Income (As a % of Sales) 1.58% 0.84% 1.65% 1.45% 1.29% 1.18% 1.07% 0.98% 0.91% 0.85% 0.83%

Interest Expense (As a % of Sales) 0.17% 0.14% 0.17% 0.75% 0.70% 0.72% 0.72% 0.72% 0.73% 0.74% 0.78%

Unusual Expense - Net 0.88% -0.14% 21.14% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Pretax Income 26.79% 24.27% 26.22% 17.01% 17.79% 18.03% 18.26% 17.56% 17.61% 17.74% 17.86%

Income Taxes 5.20% 3.82% 5.06% 5.50% 5.50% 5.50% 5.50% 6.00% 6.00% 6.00% 6.50%

Consolidated Net Income 21.59% 20.45% 21.16% 11.51% 12.29% 12.53% 12.76% 11.56% 11.61% 11.74% 11.36%

Net Income 21.59% 20.45% 21.16% 11.51% 12.29% 12.53% 12.76% 11.56% 11.61% 11.74% 11.36%

Google

Value Driver Estimation

Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

NOPLAT

EBITA:

Net Sales 49,958 59,730 65,830 75,901 87,286 97,761 109,492 122,631 134,894 148,384 154,616

Cost of Goods Sold 17,543 21,885 7,215 26,565 30,550 34,216 38,322 42,921 47,213 51,934 54,115

Depreciation 1,988 2,781 3,523 5,135 5,875 6,756 7,567 8,475 9,492 10,441 11,485

Amortization of Intangibles 974 1,158 1,078 1,152 864 648 583 408 286 200 163

Selling, General, and Administrative 9,741 12,002 13,982 17,078 19,639 21,996 24,636 27,592 30,351 33,386 34,789

Research and Development 6,593 7,910 9,832 11,385 13,093 14,664 16,424 19,621 21,583 23,741 23,965

Add: Implied Interest on Operating leases 47 59 65 140 160 185 207 231 259 285 314

EBITA 13,166 14,053 30,265 14,726 17,426 19,665 22,167 23,846 26,229 28,966 30,412

Adjusted Taxes:

Total Provisions from Income Taxes 2,916 2,552 3,331 4,175 4,801 5,377 6,022 7,358 8,094 8,903 10,050

Add: Tax shield on interest expense 32 32 43 220 237 270 305 340 381 422 463

Less: Tax on nonoperating income 305 193 419 424 433 443 453 463 473 484 495

Add: Tax shield on unusual expense 169 (33) 5,359 - - - - - - - -

Add: Tax shield on operating lease 18 23 25 54 62 71 80 89 100 110 121

Total Adjusted Taxes 2,831 2,381 8,338 4,025 4,666 5,275 5,954 7,324 8,101 8,951 10,139

Add: Increase (decrease) in deferred tax liability 1,872 1,947 1,971 1,148 1,320 1,478 1,655 2,023 2,225 2,447 2,763

NOPLAT 12,206 13,618 23,898 11,849 14,079 15,868 17,869 18,544 20,353 22,462 23,035

Invested Capital

Operating Current Assets:

Normal Cash 999 1,195 1,317 1,518 1,746 1,955 2,190 2,453 2,698 2,968 3,092

Accounts Receivable 8,585 9,390 11,556 13,283 15,275 17,108 19,161 21,460 23,606 25,967 25,512

Inventory 505 426 - 425 489 547 613 687 755 831 866

Other Current Assets 3,276 4,353 4,734 5,503 6,328 7,088 7,938 8,891 9,780 10,758 11,210

Total Operating Current Assets 13,365 15,364 17,607 20,729 23,838 26,698 29,902 33,491 36,840 40,524 40,679

Non-Interest Bearing Current Liabilities:

Accounts Payable 2,012 2,453 1,715 1,973 2,269 2,542 2,847 3,188 3,507 3,858 4,020

Income Taxes Payable 240 24 96 125 144 161 211 258 283 312 402

Deferred Income 100 139 104 121 140 156 175 196 216 237 247

Other Current Liabilities 9,536 10,422 12,985 16,162 18,634 21,430 24,001 26,881 30,107 33,118 36,430

Total Non-Interest Bearing Current Liabilities 11,888 13,038 14,900 18,382 21,188 24,289 27,234 30,523 34,113 37,525 41,099

Add: Net PPE 11,854 16,524 23,883 27,324 31,423 35,194 39,417 44,147 48,562 53,418 49,477

Total Operating working Capital 13,331 18,850 26,590 29,671 34,073 37,603 42,085 47,114 51,288 56,417 49,057

Net other operating Assets:

Capitalized PV of operating leases 2,730 3,028 4,514 6,524 7,464 8,584 9,614 10,767 12,059 13,265 14,592

Net other Intangibles 7,473 6,066 4,607 3,455 2,591 1,944 1,361 952 667 467 303

Other Assets 2,011 1,976 1,955 2,002 2,051 2,100 2,151 2,203 2,257 2,311 2,367

Net other operating Assets 12,214 11,070 11,076 11,982 12,106 12,628 13,125 13,923 14,983 16,043 17,262

Net Other Operating Liabilities

Other Liabilities 2,786 3,381 4,525 4,934 5,674 6,354 7,117 7,971 8,768 9,645 10,050

Deferred Income 100 139 104 121 140 156 175 196 216 237 247

Total Other Operaing Liabilities 2,886 3,520 4,629 5,055 5,813 6,511 7,292 8,167 8,984 9,882 10,297

Invested Capital 22,660 26,399 33,036 36,598 40,366 43,720 47,919 52,870 57,287 62,578 56,022

NOPLAT 12,206 13,618 23,898 11,849 14,079 15,868 17,869 18,544 20,353 22,462 23,035

NOPLAT 12,206.49 13,618.37 23,897.75 11,848.73 14,079.33 15,868.00 17,868.57 18,544.19 20,352.65 22,462.29 23,035.29

/Beginning Invested Capital 12,757.34 22,659.53 26,399.27 33,036.37 36,597.53 40,366.37 43,719.92 47,918.68 52,869.96 57,286.73 62,577.69

ROIC 95.68% 60.10% 90.52% 35.87% 38.47% 39.31% 40.87% 38.70% 38.50% 39.21% 36.81%

Gross Cash Flow

NOPLAT 12,206.49 13,618.37 23,897.75 11,848.73 14,079.33 15,868.00 17,868.57 18,544.19 20,352.65 22,462.29 23,035.29

+ Depreciation 1,988.00 2,781.00 3,523.00 5,134.85 5,874.75 6,755.96 7,566.68 8,474.68 9,491.64 10,440.80 11,484.88

Gross Cash Flow 14,194.49 16,399.37 27,420.75 16,983.57 19,954.08 22,623.96 25,435.25 27,018.87 29,844.29 32,903.10 34,520.17

Less: Gross Investment

Net Investment 9,902.19 3,739.74 6,637.10 3,561.16 3,768.83 3,353.56 4,198.76 4,951.28 4,416.77 5,290.96 (6,555.33)

Depreciation 1,988.00 2,781.00 3,523.00 5,134.85 5,874.75 6,755.96 7,566.68 8,474.68 9,491.64 10,440.80 11,484.88

Gross Investment 11,890.19 6,520.74 10,160.10 8,696.01 9,643.58 10,109.52 11,765.44 13,425.96 13,908.41 15,731.77 4,929.55

FCF 2,304 9,879 17,261 8,288 10,310 12,514 13,670 13,593 15,936 17,171 29,591

NOPLAT 12,206 13,618 23,898 11,849 14,079 15,868 17,869 18,544 20,353 22,462 23,035

Less: (Beginning Invested Capital) * (WACC) 856 1,520 1,771 2,216 2,454 2,707 2,932 3,214 3,546 3,842 4,197

EP 11,351 12,099 22,127 9,633 11,625 13,161 14,936 15,330 16,807 18,620 18,838

Google

Discounted Cash Flow (DCF) and Economic Profit (EP) Valuation Models

(In Millions)

Key Inputs:

CV Growth 3.20%

CV ROIC 37.91%

WACC 7.04%

Cost of Equity 7.16%

Fiscal Years Ending Dec. 31 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E CV

DCF Model

FCF 8,054 10,208 12,392 13,560 13,470 15,799 17,046 549,861

PV FCF 7,525 8,910 10,105 10,330 9,586 10,504 10,588 341,540

Value from Operations 409,088

Plus: Value of Non-Operating Assets

Excess Cash 17,030

Marketable Securities and ST Investments 46,048

Tax Loss Carryforwards 954

Discontinued Operations 104

Total Non-Operating Assets 64,136

Less: Non-Equity Claims

Total Debt (N/P, ST, LT, ST of LT) 10,298

PV of (ESOP) 2,498

Total Non-Equity Claims 12,796

Value of Equity 460,428

Shares Outstanding (Currently) 681

Intrinsic Price of Stock $676.48

Fraction of Fiscal Year Elapsed 0.29

Adjusted Intrinsic Price of Stock $682.76

EP Model

EP 9,495 11,459 12,976 14,733 15,106 16,558 18,348 485,675

PV EP 8,871 10,002 10,581 11,223 10,751 11,009 11,397 301,672

Value from Operations 409,088

Plus: Value of Non-Operating Assets

Excess Cash 17,030

Marketable Securities and ST Investments 46,048

Tax Loss Carryforwards 954

Discontinued Operations 104

Total Non-Operating Assets 64,136

Less: Non-Equity Claims

Total Debt (N/P, ST, LT, ST of LT) 10,298

PV of (ESOP) 2,498

Total Non-Equity Claims 12,796

Value of Equity 460,428

Shares Outstanding (Currently) 681

Intrinsic Price of Stock $676.48

Fraction of Fiscal Year Elapsed 0.29

Adjusted Intrinsic Price of Stock $682.76

Google

Dividend Discount Model (DDM) or Fundamental P/E Valuation Model

Fiscal Years Ending Dec. 31 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

EPS 25.87$ 31.50$ 35.89$ 40.82$ 41.31$ 45.53$ 50.55$ 50.82$

Key Assumptions

CV growth 3.20%

CV ROE 12.92%

Cost of Equity 7.16%

Future Cash Flows

P/E Multiple (CV Year)

EPS (CV Year)

Dividends Per Share 23.70 27.00 30.71 31.08 34.25 38.03 38.23 965.41

Number of Periods to discount 1 2 3 4 5 6 7 7

Discounted Cash Flows $22.11 $23.52 $24.96 $23.57 $24.24 $25.11 $23.56 $594.95

Intrinsic Value 762.02$

Fraction of Year Elapsed 29.32%

Adjusted Stock Price $777.63

Google As of 4/17/2015

Relative Valuation Models

EPS EPS Est. 5yr

Ticker Company Price 2015E 2016E P/E 15 P/E 16 EPS gr. PEG 15 PEG 16

AAPL Apple Inc. $124.75 $6.45 $8.68 19.3 14.4 13.18 1.47 1.09

FB Facebook $80.78 $1.77 $1.96 45.6 41.2 28.57 1.60 1.44

AKAM Akamai Technologies $71.90 $2.43 $2.64 29.6 27.2 15.50 1.91 1.76

MSFT Microsoft Corporation $41.62 $2.63 $2.39 15.8 17.4 7.95 1.99 2.19

VRSN VeriSign, Inc. $66.06 $2.72 $3.13 24.3 21.1 12.00 2.02 1.76

EBAY eBay Inc. $55.79 $2.95 $3.10 18.9 18.0 9.81 1.93 1.83

Average 25.6 23.2 0.9 0.4

GOOG Google $535.53 $25.87 $31.50 20.7 17.0 1.57 13.2 10.8

Implied Value:

Relative P/E (EPS15) $ 662.22

Relative P/E (EPS16) 731.43$

PEG Ratio (EPS15) 36.62$

PEG Ratio (EPS16) 17.97$

Google

Key Management Ratios

Fiscal Years Ending Dec. 31 2012 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

Liquidity Ratios

Current Ratio Current Assets/Current Liabilities 4.22 4.58 4.80 4.83 4.74 4.69 4.73 4.70 4.70 4.74 4.97

Cash Ratio Cash/Current Liabilities 3.35 3.69 3.83 3.81 3.72 3.69 3.72 3.70 3.71 3.75 4.07

Quick Ratio (CA - Inventory - Prepaid Exp.)/CL 3.95 4.28 4.52 4.51 4.43 4.39 4.42 4.39 4.39 4.44 4.68

Activity or Asset-Management Ratios

Avg Total Assets (Beg. Total Assets + End. Total Assets)/2 83186 102359 121026.5 136663.713 149750.202 165745.245 183466.56 202472.783 222700.146 244565.209 267270.989

Total Asset Turnover Net Sales/Total Assets 60.06% 58.35% 54.39% 55.54% 58.29% 58.98% 59.68% 60.57% 60.57% 60.67% 57.85%

Financial Leverage Ratios

Debt-to-equity Ratio Total Debt/Total Equity 0.24 0.20 0.18 0.13 0.14 0.15 0.16 0.17 0.18 0.19 0.20

Debt Ratio Toal Debt/Total Assets 0.24 0.21 0.20 0.20 0.21 0.21 0.21 0.22 0.22 0.22 0.22

Capitalization Ratio Long Term Debt/(Long Term Debt + Equity) 0.12 0.08 0.10 0.11 0.11 0.12 0.12 0.13 0.14 0.14 0.15

Profitability Ratios

Net Profit Margin (EBITA/Net Sales) (EBITA/Net Sales) 26.36% 23.54% 45.99% 19.42% 19.99% 20.14% 20.27% 19.47% 19.47% 19.54% 19.69%

Return on Assets Net Income/Average Total Assets 15.83% 13.74% 25.01% 10.79% 11.65% 11.88% 12.10% 11.79% 11.79% 11.86% 11.39%

Return on Investment EBITA/(Debt + Equity) 50.99% 49.93% 94.62% 45.25% 52.56% 58.23% 64.42% 68.00% 73.38% 79.47% 81.82%

Return on Equity Net Income/Average Total Equity 18.36% 16.10% 28.97% 12.98% 13.99% 14.34% 14.64% 14.37% 14.41% 14.50% 13.97%

Payout Ratios

Dividend Payout Ratio Dividends/Net Income 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%

Pre-Tax Cost

of Debt

WACC

7.04% 2.21% 2.71% 3.21% 3.71% 4.21% 4.71% 5.21%

5.16% 5.06% 5.07% 5.08% 5.09% 5.11% 5.12% 5.13%

5.66% 5.55% 5.56% 5.57% 5.58% 5.59% 5.60% 5.61%

6.16% 6.03% 6.04% 6.06% 6.07% 6.08% 6.09% 6.10%

6.66% 6.52% 6.53% 6.54% 6.55% 6.56% 6.58% 6.59%

Cost of Equity 7.16% 7.00% 7.02% 7.03% 7.04% 7.05% 7.06% 7.07%

7.66% 7.49% 7.50% 7.51% 7.53% 7.54% 7.55% 7.56%

8.16% 7.97% 7.99% 8.00% 8.01% 8.02% 8.04% 8.05%

8.66% 8.46% 8.47% 8.49% 8.50% 8.51% 8.52% 8.53%

9.16% 8.95% 8.96% 8.97% 8.98% 9.00% 9.01% 9.02%

Beta

$682.76 0.861 0.884 0.907 0.93 0.953 0.976 0.999

3.50% $1,143.44 $1,105.97 $1,070.95 $1,038.14 $1,007.34 $978.38 $951.09

4.00% $968.70 $938.27 $909.76 $882.99 $857.81 $834.09 $811.70

4.50% $841.54 $815.98 $791.99 $769.43 $748.18 $728.13 $709.18

Equity Risk Premium 5.00% $744.91 $722.90 $702.22 $682.76 $664.40 $647.07 $630.67

5.50% $669.01 $649.72 $631.57 $614.47 $598.34 $583.08 $568.64

6.00% $607.86 $590.70 $574.54 $559.31 $544.93 $531.33 $518.44

6.50% $557.55 $542.11 $527.57 $513.85 $500.88 $488.62 $476.99

CV Growth Rate

682.76$ 1.70% 2.20% 2.70% 3.20% 3.70% 4.20% 4.70%

5.54% $762.34 $841.28 $947.88 $1,099.89 $1,334.34 $1,743.54 $2,639.69

6.04% $676.62 $734.65 $809.95 $911.64 $1,056.65 $1,280.28 $1,670.60

6.54% $608.80 $652.79 $708.14 $779.97 $876.96 $1,015.27 $1,228.57

WACC 7.04% $553.84 $588.00 $629.96 $682.76 $751.26 $843.77 $975.67

7.54% $508.43 $535.49 $568.08 $608.10 $658.45 $723.78 $811.99

8.04% $470.30 $492.10 $517.91 $548.99 $587.15 $635.16 $697.46

8.54% $437.86 $455.66 $476.44 $501.06 $530.69 $567.08 $612.86

SG&A

682.76$ 19.50% 20.50% 21.50% 22.50% 23.50% 24.50% 25.50%

29.00% $1,093.41 $1,047.77 $1,002.12 $956.48 $910.85 $865.22 $819.59

31.00% $1,002.12 $956.48 $910.85 $865.22 $819.59 $773.97 $728.36

33.00% $910.85 $865.22 $819.59 $773.97 $728.36 $682.76 $637.17

COGS as % of Sales 35.00% $819.59 $773.97 $728.36 $682.76 $637.17 $591.59 $546.03

37.00% $728.36 $682.76 $637.17 $591.59 $546.03 $500.49 $454.98

39.00% $637.17 $591.59 $546.03 $500.49 $454.98 $409.50 $364.07

41.00% $546.03 $500.49 $454.98 $409.50 $364.07 $318.72 $273.46

Effects of ESOP Exercise and Share Repurchases on Common Stock Balance Sheet Account and Number of Shares Outstanding

(In millions)

Number of Options Outstanding (shares): 7

Average Time to Maturity (years): 4.30

Expected Annual Number of Options Exercised: 2

Current Average Strike Price: 215.56$

Cost of Equity: 6.83%

Current Stock Price: $535.53

2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E

Increase in Shares Outstanding: 2 2 2 2 2 2 2 2

Average Strike Price: 215.56$ 215.56$ 215.56$ 215.56$ 215.56$ 215.56$ 215.56$ 215.56$

Increase in Common Stock Account: 363 363 363 363 363 363 363 363

Change in Treasury Stock 0 0 0 0 0 0 0 0

Expected Price of Repurchased Shares: 535.53$ 572.08$ 611.13$ 652.84$ 697.39$ 744.99$ 795.84$ 850.16$

Number of Shares Repurchased: - - - - - - - -

Shares Outstanding (beginning of the year) 680 682 684 685 687 689 690 692

Plus: Shares Issued Through ESOP 2 2 2 2 2 2 2 2

Less: Shares Repurchased in Treasury - - - - - - - -

Shares Outstanding (end of the year) 682 684 685 687 689 690 692 694

VALUATION OF OPTIONS GRANTED IN ESOP

Ticker Symbol GOOG

Current Stock Price $535.53

Risk Free Rate 2.51%

Current Dividend Yield 0.00%

Annualized St. Dev. of Stock Returns 28.21%

Average Average B-S Value

Range of Number Exercise Remaining Option of Options

Outstanding Options of Shares (Mil) Price Life (yrs) Price Granted

Range 1 7.24 215.56 4.30 345.04$ 2,498$

Total 7 215.56$ 4.30 345.04$ 2,498$

Present Value of Operating Lease Obligations (2014) Present Value of Operating Lease Obligations (2013) Present Value of Operating Lease Obligations (2012)

Operating Operating Operating

Fiscal Years Ending Dec. 31 Leases Fiscal Years Ending Leases Fiscal Years Ending Leases

2015 598 2014 499 2013 466

2016 622 2015 477 2014 453

2017 634 2016 438 2015 417

2018 596 2017 418 2016 362

2019 576 2018 370 2017 326

Thereafter 3157 Thereafter 1836 Thereafter 1595

Total Minimum Payments 6183 Total Minimum Payments 4038 Total Minimum Payments 3619

Less: Interest 1122 Less: Interest 676 Less: Interest 594

PV of Minimum Payments 5061 PV of Minimum Payments 3362 PV of Minimum Payments 3025

Capitalization of Operating Leases Capitalization of Operating Leases Capitalization of Operating Leases

Pre-Tax Cost of Debt 3.71% Pre-Tax Cost of Debt 3.71% Pre-Tax Cost of Debt 3.71%

Number Years Implied by Year 6 Payment 5.5 Number Years Implied by Year 6 Payment 5.0 Number Years Implied by Year 6 Payment 4.9

Lease PV Lease Lease PV Lease Lease PV Lease

Year Commitment Payment Year Commitment Payment Year Commitment Payment

1 598 576.6 1 499 481.2 1 466 449.3

2 622 578.3 2 477 443.5 2 453 421.2

3 634 568.4 3 438 392.7 3 417 373.9

4 596 515.2 4 418 361.3 4 362 312.9

5 576 480.1 5 370 308.4 5 326 271.7

6 & beyond 576 2342.5 6 & beyond 370 1374.8 6 & beyond 326 1195.8

PV of Minimum Payments 5061.1 PV of Minimum Payments 3361.9 PV of Minimum Payments 3024.9