Google closed down yesterday finishing at $367.23 per share on a day when the rest of the market moved notably upward. Although I have been very vocal about the stock price being overvalued in my Blogging Stocks posts, (see: 10 Reasons I think Google is going down), Google remains a very good company with a growing brand providing valuable services. So this begs the question: What is GOOG stock worth?
I'm not in the prediction business, I am in the investment business. Is there a price I would pay? Certainly. That price is unquestionably less than most other investors would pay because I always look for deep value. But is there a "fair market value?"
That's a very difficult question because the price is determined by what the last trader feels the stock is worth -- not everyone, not a consensus. For example, if you own a stock that you bought at $20 and it's now trading at $40, and you are holding on long term, then you are not a factor during the day when traders are moving the price up or down a few bucks. Your opinion on the value that day is silent and has no bearing on the price.
In trying to assess what the potential appreciation of the stock might be next year I had to make an assumption about the P/E ratio. This is based on what I envision is the level most traders will be willing to pay. If you use a P/E ratio of 40 and look twelve months out and assume Google's earnings continue to grow on a slower but still strong trajectory, you are looking at a lot of potential upside from here. GOOG's trailing twelve month EPS is $6.82. If it hits EPS of $12 then you might arrive at a value of $480. These are figures commonly discussed in the business pages and by analysts. Some of the thoughtful comments I have received to my posts suggest the same thing. Of course we have read higher estimates by Piper Jaffrey analysts who reached a $600 valuation. But to get there you must allow for EPS of $15 or a P/E of 50. That I am not willing to do, are you?
Keep in mind that weighing on the stock price and earnings during this time will be increased capital expenditures (article thanks to Melly), options, higher R&D cost, continued selling of large blocks of shares by management, perhaps some acquisitions, certainly competitive pressures, minor litigation, and continuing discussion of click fraud (see: Google $90 million click fraud settlement approved by judge by the prolific Brian White).
Potential earning surprises may come from Google's ability to monetize something other than advertising. This has been very slow in coming but somehow, some way something will show up.
A share price of $480 (next year) represents a 31% gain from last nights close. Is that possible? Yes. Is it likely? I don't know.
What might a more conservative view look like? Let's say earnings only reach $11 a share and we use a P/E of 35 (double the S&P average). Then we would arrive at a price of $385 per share -- significantly less. Only a 5% gain from here, actually and where we were few days ago. All things being equal, I believe Google will do much better than that. I think that unless something unforeseen happens Google can beat $11 and come close to that 40 P/E. So fair market value might be: $11 x 40 = $440. Or for discussion's sake, half way in between the two figures (480+385/2). You get a value of about $432 per share. That is where my comfort level is with this stock as a maximum price next year -- somewhere between $430 and $440 based on what I know today. That allows for a 20% annual gain -- not unreasonable.
So what is it worth today? For starters, a 20% gain is nowhere near enough for the downside risk. Other stocks can produce this gain without the sleepless nights and maybe with greater certainty. (See my post, GE vs. Google - It's no contest!). I would need double that to achieve my deep value, including a safety factor.
For those of you that are looking for the same thing it means the stock has to go down to $314 (440 divided by 1.4) a number that is frightening to many. If you are willing to accept less gain and more risk, then today's price should be $338. If you bought at that price you might see a 30% gain. Unfortunately for many, that is far below today's price. By the way, a 30% discount to the $480 figure would still put today's value at $342. So I think we have not seen the bottom.
These prices may never be seen because they can only become reality if traders start to view the market as I do. However, the economist, John Maynard Keynes said, "It is better to be roughly right than precisely wrong." time will tell.
If I am anywhere near correct in my market assessment then caution is still justified. I already know some of you think GOOG is going higher than I would allow for and still others might be happy with a smaller gain than I would. But my question has always been why? Why take the risk? Why assume a best case scenario? Why not take advantage of other opportunities?
Disclosure: I am neither long nor short any position in GE or Google.
Sheldon Liber is the CEO of a small private investment company and the vice president for Design and Research of an Architecture & Planning firm.
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Reader Comments (Page 1 of 1)
8-03-2006 @ 11:11AM
sashamore said...
i bought 100 shares of google at the ipo..($85) and
subsequently sold half (50 shares) at $480....i still
maintain the other half (fluctuating in the mid 300s)
....do you think now is a good time for me to sell, or should i hang on in hope of an even bigger return
in the next year or so? in other words, in terms of
profit-taking, how much should be enough?
thank you for your opinion.
8-03-2006 @ 12:34PM
Andy said...
I have been investing for years and I have never seen a company like Google. It has an ever growing lead in the rapidly growing on line advetising business. It is using the cash generated to fund various incubator companies. I believe we will start to see the benefit from this strategy in the fourth quarter. I will go with the $600.00 figure. The company is extremely nimble, hiring smart people, and has a floating cell type of organizational structure that should maintain its flexibility for years to come.
8-03-2006 @ 1:55PM
sheldon said...
sashamore: You have remarkable timing, buying GOOG at it's all time low and selling at it's all time high. Actually it's all time high closing price was $475.11 so you must have sold intraday at the perfect time-- WOW. Does not seem like you need anyone's advice but since you're asking, if you are not diversified into anything else than you should be. Find a "hard asset" dividend paying company with room to grow and take something off the table.
Andy: You seem to have a lot of confidence in GOOG's upside. If you see an ROI of 65% while it moves to $600 than I imagine you have hocked everything to buy shares all year long. BTW All of the "bubble" companies did what you suggest GOOG has done. In particular AOL (bought ICQ among others to take I.M. lead) and Yahoo but their advertising dollars plummeted and are recently coming back...some.
8-03-2006 @ 2:17PM
sashamore said...
thanks andy....i bought goog at the ipo because i was in love with the product..i sold when i did because the INCREDIBLE return was making me very
nervous....i am diversified so i guess i will hang
in 'til 5-600. (friemds and relatives think i'm
nuts, but they thought i was crazy to go for the ipo in the first place.)and besides, this is the "house
money" i'm playing with..........thanks for your com-
pliments....i sure would like to fall in love again
though.
8-03-2006 @ 4:11PM
Andy said...
sashamore, I am playing with the house' money too. In my opinion none of those bubble companies compare to Google. I have never come across a company like Google that has such a lead in such a fast growing revenue producer, is so nimble and innovative and is hiring such talented people.
8-03-2006 @ 4:36PM
sheldon said...
Sashamore/Andy: History teaches us that for some reason people playing with house money usually give it back. So far you both gave some back holding on from $475 until now ($100/shr less). It is interesting and fun to play with house money and much of the risk for you seems to be worth it. Maybe Andy's operative word is "playing". You could be right in how this 'plays' out but I could not advise anyone to play along with you. If you both took some money off the table that was smart-- good luck with the rest of it.
8-03-2006 @ 7:42PM
Investorial said...
Owners in the stock should always want to sell "potential owners" on the merits of the stock at a "higher price". The market place is full of salesmen that can say.. Google's worth $1000, buy it from me for that! Meanwhile, they're only comfortable buying at $100, $200, $300, $400. The last person holding the stock when it plunges is always the sucker.
I'd like to focus on how Google keeps working on its operations, its business but unfortunately that stock price is a huge distraction.
8-03-2006 @ 7:54PM
sashamore said...
andy: the only other time i was in a run like this
was about a million years ago when POLAROID came on the market. my father and i bought it as partners at about $25 per.....my father had the $$, i had the ideas....(which i got from my psychiatrist who was getting info from another patient on the couch who just happened to be a broker..)
at any rate we got out at over $200....and i was annoyed because the stock continued to climb. my
dad taught me then to never regret taking a profit no matter how high the stock went after i left... i do regret not having that shrink anymore, though.
but yes...GOOGLE is a GREAT company. even before it went public... smart, innovative, and imo, WAY ahead of the competition. long may it wave....
8-03-2006 @ 11:17PM
Andy said...
I think Google is far ahead of the market and far a head of the times. Time will tell. This is a new world and a differnt type of company.
8-04-2006 @ 1:06PM
Sheldon said...
New company, same world, same investors.......look for same outcome.