Google/GOOG's valuation, p. 3
With each new all-time high, talk of Google/GOOG's presumed excessive valuation becomes the topic du jour. The clever essay that follows offers an interesting perspective...
The Wall Street Examiner
Friday June 10 2005
GOOG 1,000: Why it’s Possible
by Theodore Mantle
Google (NASDAQ-GOOG) stock has already more than tripled since its IPO. If it does that again, it will be trading near 1,000 dollars per share.
But is that reasonable? Is it likely? Is it even possible, within for example the next three years?
I believe most experienced stock market investors would agree that the first question is irrelevant. As long as the price keeps rising, lucky shareholders have little incentive to sell.
So how likely is it that GOOG keeps climbing to 1,000?
Those who have studied the subject of “heuristic reasoning under uncertainty” are familiar with the concept of “anchoring.” This is a psychological biasing effect that tends to make people adjust their estimates around an existing level, despite other factors that could justify a vastly different estimate.
Estimates of the future stock price of Google have been affected by precisely this kind of bias. When the stock was trading in the 180 range, most analysts were comfortable setting their short-term price targets at 200.
Once it broke above that psychological barrier, targets were quickly moved up to the 250 range. When the stock price hit 250, more calls for “GOOG 300!” were heard. Last week the stock reached a high of 299, and a 350 target was announced by one firm. Today I heard another predict 360.
When the stock was at 180, a target of 200 didn’t seem that crazy, but a target of 360 did. When the stock hit 299, a target of 360 became more psychologically acceptable. But I see very little value in setting price targets that are really nothing more than adjustments of projections to a range near the current price.
To be fair, many analysts waited for the latest earnings report from Google before adjusting their price targets. Google doesn’t provide advance estimates or mid-quarter revisions like most companies. This adds to the uncertainty. After higher earnings were reported, most firms raised their price targets using that information as a justification.
But most raised them only marginally, still clinging to the current price as an anchor.
One notable exception was the highly-regarded Value Line Investment Survey, which dramatically revised its own 3 to 5 year appreciation target to a price range of 385 to 585.
Most analysts don’t look that far ahead, and are afraid to forecast a price that lies too far outside others in the industry, to avoid the risk of appearing foolhardy should the stock suffer a serious correction.
One approach to freeing oneself from the bias of anchoring (in the hope of coming up with a more accurate estimate) is to simply choose another anchor, and then gradually adjust the estimate up or down around that point by considering numerous factors that could affect the price.
How about an anchor price of $1,000 per share for GOOG stock? Before considering if it’s likely, let’s first consider if it’s possible.
Well, on an earnings basis, it is. For the single quarter ending March 31, 2005 earnings were $1.29 per share versus $0.24 per share a year earlier. With the strong growth rate even the current consensus of analysts agree that it’s possible for full-year 2006 earnings (four quarters) to reach $10.00 per share. That would be an average of $2.50 per quarter. If the price of GOOG reached 1,000 the price/earnings ratio (p/e) would be 100. Is it possible for a stock to trade with a p/e of 100? Yes. Genentech’s (NYSE-DNA) trailing 12-month p/e is 100 right now.
What about valuation? With 277 million shares outstanding, a price of $1,000 per share means the market capitalization would be $277 billion. Is it possible for a stock to have that large a market cap? Yes. In fact right now Microsoft’s (NASDAQ-MSFT) market cap happens to be $278 Billion. Exxon-Mobil’s (NYSE-XOM) market cap is $363 Billion. General Electric’s (NYSE-GE) market cap is $391 Billion.
What about dividend yield? Is it possible for a stock to keep going up if it doesn’t even pay a dividend? Yes. Currently 71 of the NASDAQ 100 stocks (including GOOG) don’t pay any dividend at all.
What about book value? GOOG is currently trading at more than 20 times book value, so we know that a price/book ratio (p/b) over 20 is possible. Without increasing that ratio, if the price were to triple again the book value would also have to triple. Is that possible? Yes. Google’s net tangible assets at year-end 2002, 2003, and 2004 respectively were $173 Million, $483 Million and $2,700 Million. So the book value has already approximately tripled once from 2002 to 2003 (before the IPO brought in even more cash). $10.00 per share net earnings in 2006 would potentially add another $2,770 Million dollars in net tangible asset value to the company’s balance sheet, doubling the value in one year. Do it again in 2007 and it’s tripled.
So that’s why, yes, it’s possible for GOOG to reach $1,000 per share within 3 years.
Now, Value Line forecasts a maximum price during that time period of approximately $585. Isn’t that more reasonable? Yes, of course, because a p/e ratio of 100 is very high, even for a fast-growing company. A p/b ratio of 20 is also high. And to believe that the market capitalization can reach $277 Billion is quite optimistic to say the least, since that would put Google in the top 4 of all U.S. companies, right behind Microsoft. So I do think our anchor price of $1,000 is unreasonably high, although possible.
Now then, what is most likely to happen? Certainly we could revise our estimate by further refining our projections of earnings and assets, analyzing competitive risks, constructing hypothetical scenarios for Google’s business growth and considering the relative performance of the overall stock market over the next several years based on our expectations for interest rates, U.S. economic growth, money supply and a host of additional factors that other people have already analyzed ad nauseam.
If we did so, we could arrive at a more reasonable estimate of what “should” happen. I’m more interested in what “will” happen. That depends, as Adrian Van Eck is famous for saying, on what people decide to do with their money.
Psychologically, after riding the NASDAQ 1999 stock market bubble up and then back down, people are scared to repeat that mistake. The current house bubble has many people nervous, especially those who have gotten strung out on “refi madness” debt and are starting to realize that they have to pay that money back. Further mental pressure is mounting from the new tougher bankruptcy laws, which make debt avoidance more difficult. Pension plans are going bust around the country, making that income stream less safe. Social Security is widely known to be broken. Fear of terrorism is still just below the surface.
I think people today are living on the edge and will want to pull out their money at the first sign of any trouble - especially since Google is an internet company and nobody wants to face the embarrassment of being fooled again in that sector.
I expect a small crack in the price of GOOG stock to rapidly turn into a beat-thy-neighbor rush to the exits, with a re-test of 200 likely because that was the level where the latest run began. I don’t know if 360 will be hit before the big break, but I know that once it begins I sure wouldn’t want to be the last one out the door. I’d want to have my running shoes laced up tight and my elbows sharpened.
After GOOG slaps investors in the face, hot money will go elsewhere, and further upside price movement will be slow and labored while all the overhead supply is gradually absorbed from late-comers to the party selling to get out even.
Look at any of dozens of hot internet stocks from 1999 that crashed in 2000 and you’ll see that most of those (that still exist) have yet to recover even half of their previous high by 2005.
So while “GOOG 1,000!” is possible, I don’t think it’s likely. Not even within the next ten years.
Sorry if I got you a little excited earlier on.
As I said, quite clever. I have quibbles, however, with Mr Mantle's thoughts...
1) 'People are scared of repeating their mistake of watching the market go up and then down while they continue to hold' - This has ever been the case; what's new?
2) 'Google/GOOG is in the internet sector' - So, what of it? Unlike 5 years ago, Google makes ever-increasing amounts of money.
3) 'GOOG perhaps falls to $200 before climbing to $360' - It would be folly to deny the possibility of such an event, but so what? Shares oscillate, and a decline from $300 to $200 is proportionate to a $30 stock declining to $20. Would such a decline prohibit that stock to climb subsequently to $100? Check history for similar patterns...
One elliptical reason for my excitement re Google/GOOG can be found in a recent essay by Robert Cringley. This article includes understandable speculation on the part of Cringley because Google is incredibly tight-lipped. Nonetheless, as Cringley suggests, Google has a tendency to "think big". (Cringley's comments below were edited slightly by a Deipnosophist reader "to provide a completely Google context")...
"[Many readers are] doubtful about the idea that [the Google Web Accelerator] is a land grab on Google's part. More likely it is market research or an effort to make Google's own spider programs work better by uncovering previously hidden web real estate. Maybe, maybe not. But Google thinks big and they don't do frivolous public betas.
"What we can say about any public beta from Google is that it is a statement of direction and possibly an effort to influence the future. So let's think a bit further about where this accelerator thing could be going. Let's refine our vision a bit.
"Google just bought land in the Columbia Gorge east of Portland, Oregon -- 30-plus acres with options on additional parcels. What the heck is that for? This is beautiful land outside any major city. Not enough land for a corporate campus, but that's okay, because there isn't much in the way of local housing, anyway. So what's it for?
"It is probably for a data center -- a one million-plus square foot data center that could easily be inhabited by a million or more CPUs. The attraction for Google is reliable electrical power since their new property is not far from one of the many dams and powerhouses that make up the Bonneville Power System.
"Now drop back to the Google Web Accelerator. Yes, it is just one of many Google initiatives. Yes, it can be circumvented in a number of ways. But Google is planning something big, so how could the Web Accelerator be a part of that?
"What did Bill Gates say? That Apple's iPod was at best a transitional technology to be supplanted by mobile phones? Well, it is true that we'll all eventually carry phones. And it is true that we are all wanting more and more information. And it is undeniably true that the current view of the World Wide Web from most so-called "Internet-enabled" mobile phones is pretty pitiful. Enter one possible version of the Google Web Accelerator as an intelligent web interface generator for mobile users. There is no other project I have heard of that could -- on-the-fly -- convert web content for this new interface, which happens to be used by more than a billion people worldwide."
It is easy to seque from the talk of Google/GOOG's valuation to Cringley's thoughts re one aspect of the 'big picture' for the company because Google/GOOG is more than merely another stock investment (expressed as its financials), more than just another company (its place within its sector and the economy); au contraire, in my reckoning Google manifests as the vanguard of the changes society itself demands, and has wrought. It represents the apotheosis of all these trends.
Although the stock is not the company, its reality as apotheosis should help propel its share price higher for some time yet... punctuated, of course, by periods of skittish stock behavior. (It would not surprise me to see the shares trade between ~$300 and $250 -- if it even declines that low -- for the next several weeks, as it traces out a short term base prefatory to another leg higher. Only the fullness of time shall reveal the final shape of its pattern.) Please understand: although the topology is (and will be) rocky at times, it is generally uphill. Even from current levels of price and valuation.
Questions? Comments?
The Wall Street Examiner
Friday June 10 2005
GOOG 1,000: Why it’s Possible
by Theodore Mantle
Google (NASDAQ-GOOG) stock has already more than tripled since its IPO. If it does that again, it will be trading near 1,000 dollars per share.
But is that reasonable? Is it likely? Is it even possible, within for example the next three years?
I believe most experienced stock market investors would agree that the first question is irrelevant. As long as the price keeps rising, lucky shareholders have little incentive to sell.
So how likely is it that GOOG keeps climbing to 1,000?
Those who have studied the subject of “heuristic reasoning under uncertainty” are familiar with the concept of “anchoring.” This is a psychological biasing effect that tends to make people adjust their estimates around an existing level, despite other factors that could justify a vastly different estimate.
Estimates of the future stock price of Google have been affected by precisely this kind of bias. When the stock was trading in the 180 range, most analysts were comfortable setting their short-term price targets at 200.
Once it broke above that psychological barrier, targets were quickly moved up to the 250 range. When the stock price hit 250, more calls for “GOOG 300!” were heard. Last week the stock reached a high of 299, and a 350 target was announced by one firm. Today I heard another predict 360.
When the stock was at 180, a target of 200 didn’t seem that crazy, but a target of 360 did. When the stock hit 299, a target of 360 became more psychologically acceptable. But I see very little value in setting price targets that are really nothing more than adjustments of projections to a range near the current price.
To be fair, many analysts waited for the latest earnings report from Google before adjusting their price targets. Google doesn’t provide advance estimates or mid-quarter revisions like most companies. This adds to the uncertainty. After higher earnings were reported, most firms raised their price targets using that information as a justification.
But most raised them only marginally, still clinging to the current price as an anchor.
One notable exception was the highly-regarded Value Line Investment Survey, which dramatically revised its own 3 to 5 year appreciation target to a price range of 385 to 585.
Most analysts don’t look that far ahead, and are afraid to forecast a price that lies too far outside others in the industry, to avoid the risk of appearing foolhardy should the stock suffer a serious correction.
One approach to freeing oneself from the bias of anchoring (in the hope of coming up with a more accurate estimate) is to simply choose another anchor, and then gradually adjust the estimate up or down around that point by considering numerous factors that could affect the price.
How about an anchor price of $1,000 per share for GOOG stock? Before considering if it’s likely, let’s first consider if it’s possible.
Well, on an earnings basis, it is. For the single quarter ending March 31, 2005 earnings were $1.29 per share versus $0.24 per share a year earlier. With the strong growth rate even the current consensus of analysts agree that it’s possible for full-year 2006 earnings (four quarters) to reach $10.00 per share. That would be an average of $2.50 per quarter. If the price of GOOG reached 1,000 the price/earnings ratio (p/e) would be 100. Is it possible for a stock to trade with a p/e of 100? Yes. Genentech’s (NYSE-DNA) trailing 12-month p/e is 100 right now.
What about valuation? With 277 million shares outstanding, a price of $1,000 per share means the market capitalization would be $277 billion. Is it possible for a stock to have that large a market cap? Yes. In fact right now Microsoft’s (NASDAQ-MSFT) market cap happens to be $278 Billion. Exxon-Mobil’s (NYSE-XOM) market cap is $363 Billion. General Electric’s (NYSE-GE) market cap is $391 Billion.
What about dividend yield? Is it possible for a stock to keep going up if it doesn’t even pay a dividend? Yes. Currently 71 of the NASDAQ 100 stocks (including GOOG) don’t pay any dividend at all.
What about book value? GOOG is currently trading at more than 20 times book value, so we know that a price/book ratio (p/b) over 20 is possible. Without increasing that ratio, if the price were to triple again the book value would also have to triple. Is that possible? Yes. Google’s net tangible assets at year-end 2002, 2003, and 2004 respectively were $173 Million, $483 Million and $2,700 Million. So the book value has already approximately tripled once from 2002 to 2003 (before the IPO brought in even more cash). $10.00 per share net earnings in 2006 would potentially add another $2,770 Million dollars in net tangible asset value to the company’s balance sheet, doubling the value in one year. Do it again in 2007 and it’s tripled.
So that’s why, yes, it’s possible for GOOG to reach $1,000 per share within 3 years.
Now, Value Line forecasts a maximum price during that time period of approximately $585. Isn’t that more reasonable? Yes, of course, because a p/e ratio of 100 is very high, even for a fast-growing company. A p/b ratio of 20 is also high. And to believe that the market capitalization can reach $277 Billion is quite optimistic to say the least, since that would put Google in the top 4 of all U.S. companies, right behind Microsoft. So I do think our anchor price of $1,000 is unreasonably high, although possible.
Now then, what is most likely to happen? Certainly we could revise our estimate by further refining our projections of earnings and assets, analyzing competitive risks, constructing hypothetical scenarios for Google’s business growth and considering the relative performance of the overall stock market over the next several years based on our expectations for interest rates, U.S. economic growth, money supply and a host of additional factors that other people have already analyzed ad nauseam.
If we did so, we could arrive at a more reasonable estimate of what “should” happen. I’m more interested in what “will” happen. That depends, as Adrian Van Eck is famous for saying, on what people decide to do with their money.
Psychologically, after riding the NASDAQ 1999 stock market bubble up and then back down, people are scared to repeat that mistake. The current house bubble has many people nervous, especially those who have gotten strung out on “refi madness” debt and are starting to realize that they have to pay that money back. Further mental pressure is mounting from the new tougher bankruptcy laws, which make debt avoidance more difficult. Pension plans are going bust around the country, making that income stream less safe. Social Security is widely known to be broken. Fear of terrorism is still just below the surface.
I think people today are living on the edge and will want to pull out their money at the first sign of any trouble - especially since Google is an internet company and nobody wants to face the embarrassment of being fooled again in that sector.
I expect a small crack in the price of GOOG stock to rapidly turn into a beat-thy-neighbor rush to the exits, with a re-test of 200 likely because that was the level where the latest run began. I don’t know if 360 will be hit before the big break, but I know that once it begins I sure wouldn’t want to be the last one out the door. I’d want to have my running shoes laced up tight and my elbows sharpened.
After GOOG slaps investors in the face, hot money will go elsewhere, and further upside price movement will be slow and labored while all the overhead supply is gradually absorbed from late-comers to the party selling to get out even.
Look at any of dozens of hot internet stocks from 1999 that crashed in 2000 and you’ll see that most of those (that still exist) have yet to recover even half of their previous high by 2005.
So while “GOOG 1,000!” is possible, I don’t think it’s likely. Not even within the next ten years.
Sorry if I got you a little excited earlier on.
As I said, quite clever. I have quibbles, however, with Mr Mantle's thoughts...
1) 'People are scared of repeating their mistake of watching the market go up and then down while they continue to hold' - This has ever been the case; what's new?
2) 'Google/GOOG is in the internet sector' - So, what of it? Unlike 5 years ago, Google makes ever-increasing amounts of money.
3) 'GOOG perhaps falls to $200 before climbing to $360' - It would be folly to deny the possibility of such an event, but so what? Shares oscillate, and a decline from $300 to $200 is proportionate to a $30 stock declining to $20. Would such a decline prohibit that stock to climb subsequently to $100? Check history for similar patterns...
One elliptical reason for my excitement re Google/GOOG can be found in a recent essay by Robert Cringley. This article includes understandable speculation on the part of Cringley because Google is incredibly tight-lipped. Nonetheless, as Cringley suggests, Google has a tendency to "think big". (Cringley's comments below were edited slightly by a Deipnosophist reader "to provide a completely Google context")...
"[Many readers are] doubtful about the idea that [the Google Web Accelerator] is a land grab on Google's part. More likely it is market research or an effort to make Google's own spider programs work better by uncovering previously hidden web real estate. Maybe, maybe not. But Google thinks big and they don't do frivolous public betas.
"What we can say about any public beta from Google is that it is a statement of direction and possibly an effort to influence the future. So let's think a bit further about where this accelerator thing could be going. Let's refine our vision a bit.
"Google just bought land in the Columbia Gorge east of Portland, Oregon -- 30-plus acres with options on additional parcels. What the heck is that for? This is beautiful land outside any major city. Not enough land for a corporate campus, but that's okay, because there isn't much in the way of local housing, anyway. So what's it for?
"It is probably for a data center -- a one million-plus square foot data center that could easily be inhabited by a million or more CPUs. The attraction for Google is reliable electrical power since their new property is not far from one of the many dams and powerhouses that make up the Bonneville Power System.
"Now drop back to the Google Web Accelerator. Yes, it is just one of many Google initiatives. Yes, it can be circumvented in a number of ways. But Google is planning something big, so how could the Web Accelerator be a part of that?
"What did Bill Gates say? That Apple's iPod was at best a transitional technology to be supplanted by mobile phones? Well, it is true that we'll all eventually carry phones. And it is true that we are all wanting more and more information. And it is undeniably true that the current view of the World Wide Web from most so-called "Internet-enabled" mobile phones is pretty pitiful. Enter one possible version of the Google Web Accelerator as an intelligent web interface generator for mobile users. There is no other project I have heard of that could -- on-the-fly -- convert web content for this new interface, which happens to be used by more than a billion people worldwide."
It is easy to seque from the talk of Google/GOOG's valuation to Cringley's thoughts re one aspect of the 'big picture' for the company because Google/GOOG is more than merely another stock investment (expressed as its financials), more than just another company (its place within its sector and the economy); au contraire, in my reckoning Google manifests as the vanguard of the changes society itself demands, and has wrought. It represents the apotheosis of all these trends.
Although the stock is not the company, its reality as apotheosis should help propel its share price higher for some time yet... punctuated, of course, by periods of skittish stock behavior. (It would not surprise me to see the shares trade between ~$300 and $250 -- if it even declines that low -- for the next several weeks, as it traces out a short term base prefatory to another leg higher. Only the fullness of time shall reveal the final shape of its pattern.) Please understand: although the topology is (and will be) rocky at times, it is generally uphill. Even from current levels of price and valuation.
Questions? Comments?
posted by David M Gordon | 12:36 PM
<< Home