Google valuations

Discussion in 'Stocks' started by Comanche, Oct 15, 2007.

  1. Talk of Google $1,000 Evokes Cheers, Jeers


    NEW YORK -- Whether it's Dow 10000, $50-a-barrel oil or some other benchmark, investors get excited about big, round numbers.

    That's why it isn't surprising to hear the buzz over the prospect of Google Inc. (GOOG), arguably the hottest company of the decade, seeing its stock price hit four digits. That would still leave it two digits shy of Warren Buffett's money machine Berkshire Hathaway Inc. (BRKA), although it would be worth about 60% more at a market value of $312 billion. Some analysts even have speculated that Google could be the world's first trillion-dollar stock -- a fitting fate for a company named after the number googol, which is one followed by 100 zeroes.

    Google has had more than its share of doubters and has made them look foolish time and again as it broke through milestones like $100 a share the day of its 2004 IPO, $200 at the beginning of 2005 and $500 early this year. The latest milestone of $600, coming after the stock market's recent bout of turbulence, seemed to briefly accelerate the stock's momentum, sending it as high as $641 within two sessions. It also sent analysts who are hesitant to downgrade the stock -- they almost all have buy ratings -- to lift their target prices.

    Take Lehman Brothers analyst Douglas Anmuth, who promptly increased his target as soon as Google crossed the $600 barrier. It went from $610 to $714, ostensibly in anticipation of a "G-phone" coming in 2008, but it's hard to see how a vague project already under discussion can add $33 billion to any company's value, even Google's. It's more an exercise in justifying a continued buy rating on a hot stock.

    "What's happening is nothing's changing but it's worth more than it used to be," said Mark Mowrey, a technology analyst at Al Frank Funds, which doesn't own Google. "Analysts are coming to the conclusion that what's going up continues to go up. They don't want to put a sell on it because they'd look like idiots."

    Hitting the $600 barrier sparked fresh chatter about an eventual price of $1,000, now just 61% away. Momentum could carry it there, but does it matter?

    "It might be a self-fulfilling thing but, ultimately, it's just an arbitrary price," said Thomas McKeon, portfolio manager at West Chester Capital Advisers, who also doesn't own Google.

    Some have pointed out that a higher valuation could be justified given the stock's discount to rival Yahoo Inc. (YHOO), but this seems like a stretch. Yahoo is in turnaround mode, and crimped earnings have temporarily boosted its prospective price to earnings multiple to a level that, if applied to Google, would make it worth almost exactly $1,000. P/E multiples aside, reaching $1,000 any time soon would require some suspension of disbelief, Mowrey said.

    "$1,000 is a nice number, but it's a huge jump," he said. "That makes it bigger than Microsoft (MSFT) -- that would be ludicrous to me."

    One bullish blogger outlines a back-of-the-envelope calculation that gets Google there even as it slides to a less lofty valuation of 20 times trailing 12-month earnings versus the current 51 times. With online advertising growing from the current 3.5% of the total ad market to 25% and Google's share slipping to a mere 35% from its current 45%, annual revenue could grow to $57 billion and earnings per share to $56.88 for an imputed stock price of $1,140, which also assumes some dilution from options issuance.

    The calculation appears flawed on many levels. First, online ad sales already are about double what the blogger assumes, and net margins of 20% as a mature media company appear unrealistic. What's more, Mowrey points out that the low barriers to entry and a constantly shifting online landscape make it hard to assume such high market share going forward.

    "If their share were to slip, that would be pretty bad for the stock," he said. "We already know anecdotally that devotion on the net is pretty fickle."

    Not to be outdone, former Internet analyst Henry Blodget of "Amazon $400" fame caused an uproar in the blogosphere last week when he posted a "Google $2,000" story on his blog, Silicon Alley Insider.

    "Well, first it's worth noting that Google is now almost a third of the way there. Second, it's worth noting that $2,000 a share would mean a market cap of about $750 billion, which -- given a reasonable time horizon -- just isn't that far-fetched," he wrote. In fairness to Blodget, he makes clear that he was merely thinking out loud, not making a prediction. Judging from the flak he received, many readers didn't read past the headline.

    "Google could peak today and head for zero tomorrow and leave everyone who ever considered buying it at $600 wondering what on earth they were smoking. And if it does go to zero, don't come whining to us," he wrote. Blodget also makes clear a basic point many bulls seem to be missing: that returns are time-dependent. For example, reaching $2,000 in 20 years would garner a subpar 6% annual return, below the long-run average for stocks. The same applies to reaching $1,000 in a decade, which would yield only a 4.9% compound annual return.

    Debunking amateurish valuations of Google isn't hard, but even pros take some liberties with their models. Take the discounted cash flow valuation by Morgan Stanley analyst Mary Meeker, dubbed "Queen of the Net," which was highlighted by this columnist on Aug. 28 ("Internet Analyst Smackdown Over Google"). Her $645 target price consisted of $135 in net present value of the next 10 years' cash flows, $44 in net cash and a massive $466 in "terminal value."

    Ratcheting down terminal growth to a level consistent with accepted valuation principles taught in any business school -- i.e., no faster than the nominal growth in GDP -- yields $557 a share. Trimming compound annual free cash flow growth to a still-blistering 20% produces a value of $319 and a still-decent 10% annual growth rate yields a target of $173.

    Still, even if its value is hard to decipher, momentum counts for a lot in the short run. As much as he's skeptical of its valuation, McKeon has a healthy-enough respect for a hot stock that he wouldn't recommend making an explicit bet against Google.

    "As John Maynard Keynes said, the market can remain irrational a lot longer than you can remain solvent. I wouldn't short this with a 10 foot pole."

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    (Spencer Jakab previously wrote the STREET SAVVY column, which has been rebranded as TAKING STOCK, a new global column which gives insightful analysis about equity-related topics around the world.)