Shares of Internet search company Google (GOOG 332.00) have fallen to their lowest valuation since the company's IPO in 2004.  We believe this a good time for investors to initiate long-term positions in GOOG.

In October 2007 GOOG rose to an all-time high of $747.24 and sported a trailing 12-month price-to-earnings ratio of 57x as analysts continually raised their price targets and earnings estimates. Since that time, GOOG has fallen 56% to a trailing 12-month multiple of 22x.

Although the company will likely face some near-term headwinds due to global economic weakness, its long-term growth story remains intact, creating a compelling valuation.

Advertising Firm

Although Google provides technology services to individuals, the vast majority (97%) of its revenue generation is through advertising. Companies pay to place text-based advertisements next to Google Web search results. Because prices are based on a bidding system based on keywords, both big and small firms are able to utilize Google to buy ads that are relevant to their respective business. Ads are typically sold on a paid-per-click basis, meaning if a user does not click on the ad, the advertiser does not pay a fee.

Google also partners with other Web sites that display Google ads and/or have a Google search bar. Google then shares a portion of the advertising revenue with partners.  There is no fee to participate in the program, encouraging both small and big Web sites to partner with Google.

With the 2008 acquisition of DoubleClick, Google has the ability to allow sites to place more interactive ads, presenting a good opportunity for Google to increase sales to companies that want more than just text-based ads.

Strong Outlook

Google's easy-to-use and uncluttered interface has allowed the company to continue to capture search market share from competitors.  As Google expands its brand presence through its innovative product offerings, we expect its market share to continue to grow.

If approved by regulators, Google is poised to make a competitor into a partner through a recent agreement with Yahoo! (YHOO), the second most popular search engine.  Under the terms of the deal, which was made in June after Yahoo rejected a buyout offer from Microsoft (MSFT), Yahoo will run Google ads in North America in return for a share in revenue. 

The government has expressed antitrust concerns because Yahoo and Google command 90% of the search market, so companies have voluntarily delayed the implementation of the agreement.  While it is unclear if the partnership will be blocked, the fact that the pricing is auction based increases the chances it will be approved. Google is currently partnered with AOL and Ask.com. 

On top of market share gains, Google will benefit from the continuation of strong growth in Internet advertising spending as more consumers and businesses embrace the Internet:

*Advertising spending estimates from ZenithOptimedia. Google estimates from Thomson Reuters
**Google revenue is less traffic acquisition costs (the share of revenue paid to content partners)

Other Potential Revenue Growth Opportunities

Products such as Google Mail, Google Checkout, web browser, entrance into traditional media outlets and the acquisition of YouTube.com have yet to be profitable, which is a common criticism Google faces.  However, they do increase Google's brand presence and search traffic, which in turn generates ad revenue. 

In addition, the products are a potential future revenue source as Google works toward monetization -- such as its recent initiative to add click-to-buy links to Amazon and iTunes on YouTube music videos. We expect Google's culture of innovation will encourage further product improvements and developments.

Similar to positioning itself to benefit from the boom in Internet advertising growth, Google is positioning itself to capitalize on the fast growing mobile advertising market through its recently created mobile phone operating system and partnerships with major wireless providers.

Mobile ad spending is expected to grow from from $1.7 billion in 2007 to between $10 billion and $15 billion 2011, according to Heavy Reading, a telecom research firm. This means Google may see up to $9.2 billion in revenue from mobile search in 2011, assuming Google maintains its Nielsen Media estimated 61% mobile search market share. 

Strong Financial Position

Google generates a large amount of cash from operations and, as a result, has a hefty $12.7 billion in cash and short-term investments.  The company doesn't have any long-term debt.  This will aid in Google's ability to invest in the future and will allow the company to navigate through this time of economic uncertainty.

*data from Thomson Reuters

Attractive Valuation

Given Google's healthy growth prospects, its stock offers an attractive valuation for investors.

*data from Thomson Reuters

Expect to see some volatility:

Google's biggest risk in the near term is weakness in the global economy, which will likely cause companies to cut back on ad spending and therefore crimp Google's revenue growth.  If Google is unable to rein in costs and capital expenditures as revenue growth slows, profit margins will decrease, and its near-term earnings expectations will be lowered.

Although Google is the dominant name in search, there is always the possibility of a competitor creating a better search engine.  Microsoft, which has access to more resources, has made it clear that it wants to expand its search capabilities.  In addition, Google's partnership with Yahoo may be rejected by regulators, which would raise the possibility of Microsoft renewing its attempt to acquire Yahoo.

A total of 52% of Google's revenue comes from outside the United States.  If the dollar holds or extends its recent gains, Google may be negatively impacted in the fourth quarter and in 2009.  The company does participate in  hedging programs, which should offset some of the negative currency impact.

Summary

Shares of Google are likely to see some volatility in the near term as revenue growth slows due to the sluggish world economy. However, Google has the financial resources to weather a worldwide economic slowdown.

Once the global market recovers, the company is positioned to dominate search as well as benefit from increased Internet and mobile advertising revenue.  As a result, Google's current price marks a good time for long-term oriented investors to initiate a position.

(Disclosure: Briefing.com has a business relationship with Google, Microsoft, Yahoo! and AOL).

--Ryan McShane, Briefing.com

Industrial conglomerate 3M (MMM 56.69) produces an array of business and industrial goods as well as numerous healthcare and consumer products.  Its portfolio holds popular brands like Thinsulate, Scotch, and Post-it.  Last year, those products helped 3M generate more than $24 billion in revenue and over $4 billion in net income. 

Shares of MMM have fallen considerably this year amid fears of a cyclical slowdown and broad-based market mayhem. This blue chip company is now trading at its cheapest price in years, however, representing a solid long-term play for value-oriented investors.

A Healthy Leader

3M is lean.  It holds around $4 billion in long-term debt, which gives it a very low debt-to-capital ratio of 0.3.  Meanwhile, peers General Electric (GE) and Textron (TXT) both sport ratios of 0.8 and 0.7, respectively.  At just 0.2, Tyco (TYC 28.60) has the lowest debt-to-capital ratio of the group.

The lack of leverage means 3M holds little interest-bearing debt and that has kept it in good financial standing.  3M's operating earnings typically cover its interest expense by a multiple of 30x.  Its credit rating has gone unchanged since 1998, when Moody's assigned it a rating of Aa1 and Standard & Poor's assigned it a AA rating. 

Additionally, 3M's margins are the best among its peers.  For the last five years the company has consistently generated operating margins exceeding 20%.  It expects overall operating margins to range from 22.5% to 23.5% going forward. 

Those higher margins have made for richer profits and are helping drive stronger investment returns.  Return on invested capital has been 22% year-to-date.  The return is far better than any of 3M's competitors, though it is actually a bit lower than the company's three-year average of 24%.

Strong Growth

In order to maintain a minimum return on capital of 20%, 3M is targeting at least 10% earnings per share growth.  Earnings per share have grown 11% year-to-date, putting the company on track to hit analysts' consensus forecast of $5.48 per share.

Through the second quarter of fiscal 2008 revenue is growing at a 9% rate, which is close to the double-digit clip the company is targeting and the rate expected by Wall Street. 

Foreign sales are expected to represent about 65% of the top line in 2008, increasing to more than 70% by 2010.  Roughly 30% of total global sales are coming from emerging markets, which have grown at a 20% annual rate over the past five years.  That kind of growth will keep 3M focused on acquiring emerging business opportunities. 

Emerging economies not only demand 3M's industrial and technological products to enhance infrastructure and capital projects, but rising consumer classes are demanding more of the company's products as well.  Though there is concern the global economy will slow, growth in emerging markets will undoubtedly continue to outpace mature markets for some time. 

Value Hallmarks

Shares of MMM are trading at a five-year low.  The company's price-to-earnings ratio, now at just 10.9x trailing earnings, is also at a 5-year low and is substantially below the average multiple for the past five years of 19.7x.

3M's earnings power, though, remains strong.

Wall Street currently expects 3M to earn $5.48 per share in 2008 and $5.92 per share in 2009.  That means shares trade at 10.5x expected 2008 earnings and 9.7x expected 2009 earnings. 

3M's earnings power has enabled it to return cash to shareholders.  Year-to-date, shareholders have received nearly $1.8 billion through dividends and share buybacks.  We expect the dividend to continue rising too. 

The company's strong financial health and impressive earnings and cash flow has enabled 3M to increase its dividend every year since 1999.  Its payout ratio still remains below 35%.

Large-scale share buybacks are likely to be ongoing as well.  The company achieved record buybacks in 2007 and has consistently reduced the number of outstanding shares every year since 2003.

Free cash flow is the driver behind dividends and share repurchases.  During the most recent quarter 3M converted nearly all of its net income into free cash flow.  That means almost every dollar earned remained available for reinvestment or return to stockholders.

3M generates more cash per share than any of its peers.  Its rich cash stream is owed to 3M's sustainable business model and operational proficiency. 

*Result of more than $5 billion in noncash items, company actually posted a loss for fiscal 2007

Near-Term Threats

Weakness in the LCD industry has created a stiff, near-term headwind for 3M's optical sales.   Optical sales dropped 36% in the most recent quarter, causing sales growth in the overall display and graphics segment to turn negative.  The weakness stems from the broader economy.  Softer volume and price pressure are expected to continue.   

3M is already looking to transition its optical division into a broad-based supplier for the LCD display industry.  The effort is aimed at becoming a long-term supplier to key customers, while participating in future growth and stability from the maturing market. 

Still, price pressures and a demand for innovation remain. 

Ongoing weakness in the U.S. housing and automotive industries also represents a challenge to 3M in the near term.  However, 3M has a domestic concentration in growth industries like health care, security, government, and even consumer staples that have been a mitigating factor.

Separately, 3M's broad, international portfolio helped the company recently post its sixth consecutive quarter of record sales. 

A Prime Time to Buy

Shares of MMM are trading at a five-year low as the market factors global economic and financial concerns into the stock.  We think the stock is oversold and detached from its fundamentals.

3M is a lean and healthy company that is well diversified, and touts strong earnings power and impressive free cash flow. 

The sell-off in 3M has afforded long-term investors an opportunity to acquire a blue chip company at an attractive price.

--Jeffrey Ham, Briefing.com