Synthesis

As a result of the new share offering to raise ~$4Billion, an interesting albeit old argument reforms itself around whether the current valuation for Google/GOOG represents too-high a valuation. Or whether the offering presents a fetching price. (Embedded links follow.)

Thesis → Antithesis → Synthesis

(Jim Cramer's thesis of the valuation argument follows. Unfortunately, his site requires registration, so I reluctantly paste the comments in full below. From Allan Harris of All Allan)

Your comments re the whole megillah...?
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Jim Cramer's argument in favor:

Whether it's $4 billion in Google/GOOG stock that's for sale in this offering or $40 billion, in the end, it will be absorbed and absorbed at a less-than-huge discount. Because Google's got earnings, and someone's going to pay for those earnings.

Sure, we can fret that this is new spending money. What are they going to do with it? Buy Time Warner? Just kidding.

Still, the issue is that there's a potential for $10 in earnings power in 2007 for this company, given the astounding lack of competition and the potential for it to monetize paid search. Something has to be paid for that $10.

It's simply a "solve for M" situation, M being the multiple you want to pay for it.

There are a couple of ways to solve for M. There's the value, pristine way, which will produce nothing that can work. And there's the practical, relative way, in which you look at where other stuff that is like Google is trading, and you create the mosaic of M, which I will share with you now because it is what I used to do at my hedge fund.

First, I recognize that solving for M is distinctly soft algebra. How much certainty is there to the $10 EPS number? Frankly, it is possible; it isn't even a stretch if everything goes to plan, which, of course, means above plan.

But I like to say immediately that such a possibility leaves no room for doubt. So let's give it a haircut. Let's take 10% off that number. Say it will only earn $9. Give us some margin for error.

Now, what's the growth rate? Google's been growing about 35%. I expect that the growth rate can accelerate as it begins to monetize even more than just paid search. Again, though, let's say it doesn't. Leave it at 35%. I have been willing to pay as much as twice the growth rate in price-to-earnings ratio, but no higher. That yields a 70 P/E maximum. Right now, I could plug that in and come up with 70 times $9, which equals $630. Wow, and whoa! Too ridiculous. Right?

Consider, though, if you own Yahoo/YHOO: You are paying that same P/E for a growth rate that is less than Google's. If you own Whole Foods/WFMI, one could argue that you are paying almost the same multiple for growth that is two-thirds as good.

So what do you do? Do you sell Yahoo! and Whole Foods, two winners, because they are ridiculously overpriced? Or do you say, "Hold it, I have made good money with those two. Maybe I will pay 70 times earnings for Google." Right there, you've got pure mutual fund-think, and you can see why I believe this Google offering will be put away pretty effectively. Because the stock is $350 below where the guys who own Yahoo! or Whole Foods, or eBay/EBAY or Broadcom/BRCM, for that matter, are already willing to pay.

So, stick a pin in that thinking.

Now, I like to say, "Wait, what's the global outlook like for growth?" I believe it is slowing. I believe that rates could peak soon, and that growth is throttling back because of high prices for commodities and homes. In a slowing growth environment, what should I be willing to pay for the stock of a company stock that doesn't have much economic sensitivity at all and could keep growing at the same pace while the world slows?

Look out, you aren't going to like this answer: I believe that a company like that deserves a super-premium. Maybe I will even waive my 2 times growth rate rule and put a 3 times growth rate multiple in place, as I have paid in other times when the economy was shifting down because of the Fed. I have done that on Procter & Gamble (PG) , Pepsi (PEP) , Best Foods and on Anheuser-Busch (BUD) . Maybe I'll do it here. What would that yield?

Ninety times 9 = $810. Holy moley, don't mention that, please! They will lock me up.

OK, so now let's backtrack. Let's say that the $9 I am using is really $8. Let's say the growth shifted to 25%, a decline no one is forecasting. Let's give that 2 times the growth, meaning a 50 multiple, and multiply that by $8. That comes out at $400.

Oh, no, still ridiculous.

At this point, I usually then turn to nearer-term earnings, and say, "OK, what's the multiple on the $7 I believe Google can earn next year, because these other formulas are too bullish and don't take into account things I can't foresee in Google's business or the macro environment."

Let's say that the growth rate slows to 25% next year. Let's give that 2 times. Fifty times $7 yields $350.

And that's been my target. That's how I get there. You can see that I have to stretch and cajole and shrink all my data to come up with a target as low as $350, and I only do that because, well, I don't want to give you the real skinny 'cause it is too bullish and too many things can go wrong.

But when you use that kind of analysis, which is as "conservative" as it comes in the "solve for M" game, you realize that where you buy Google on this print will be a pretty good investment, maybe even better than you have a right to expect, because the temporary supply imbalance yields a lower price than you would otherwise expect.

Consider it a birthday present from Google to you.

Happy birthday.
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Although the terrain might be uneven, even rocky at times, the topology remains uphill (up in price).