My favorite metric for an analysis of this type is the PEG ratio.
This considers both the PE ratio of a stock and its expected growth
over the next five years. I obtained the PEG ratios for Google
(2.67), Yahoo (2.84), and Microsoft (1.67) from the following Key
Statistics pages at Yahoo Finance:
http://finance.yahoo.com/q/ks?s=GOOG
http://finance.yahoo.com/q/ks?s=YHOO
http://finance.yahoo.com/q/ks?s=MSFT
Given that a traditional interpretation is that a company is fairly
valued if its PEG ratio does not exceed 1.0, all of these companies
are "overvalued." "PEG Ratio" Moneychimp.com
http://www.moneychimp.com/articles/valuation/peg.htm. However, there
is no doubt that Google and Yahoo are experiencing tremendous growth,
whereas Microsoft is not. Some additional useful statistics can be
found on the following Analyst Estimates pages at Yahoo Finance:
http://finance.yahoo.com/q/ae?s=GOOG
http://finance.yahoo.com/q/ae?s=MSFT
http://finance.yahoo.com/q/ae?s=YHOO
By reviewing the Earnings History, we see that both Google and Yahoo
have pretty consistently outpaced the analysts' estimates by
double-digit percentages. In contrast, Microsoft has missed three of
the last four quarters. Microsoft's growth has also been pretty
anemic over the past five years, but analysts are assuming that the
release of new products including Vista and a new version of Office
will almost double its future growth rate to 11.5% over the next five
years compared with the previous five years. In comparison, Yahoo and
Google are growing much faster than Microsoft, with Google currently
growing at an annual rate of more than double that of Yahoo.
The question you pose is that if Google maintains its expected growth
rate over the next year, can it be reasonably expected to reach $550
per share. The current analyst estimate for earnings is $8.71 per
share. This would give Google a PE of 63.15 on a trailing 12 months
basis if it achieves its expected growth rate of 47.9%. Its current
PE is 103.29. Google's five-year growth rate is expected to be 30%
per year, whereas Yahoo is expected to grow at 25% per year. Yahoo's
PE is only 37.25 on expected growth next year of 28.8%.
It is clear that Google's PE will decrease if its growth rate
decreases as anticipated. This compression may be quite dramatic if
the market has priced in continued favorable earnings surprises that
do not occur. Merely meeting its expected growth rate may actually
significantly disappoint the market because of its strong history of
exceeding estimates. Favorable earnings surprises result in a lower
PE than predicted because of higher-than-expected growth.
Analysts may be becoming less conservative in their estimates, making
over achievement much more difficult. "Google now trades at 48 times
the earnings Wall Street analysts expect for 2006. Is that too much?
Maybe, but not if you think influential Citigroup (C) Smith Barney
analyst Mark Mahaney is right. On Dec. 9 he sharply increased his
estimates by nearly 60 cents a share. Now he says Google will earn
$8.84 a share in 2006, in part because it gained 10 points of market
share in 2005. That puts Google's price-earnings ratio at 48. "We are
removing what was an overly conservative bias in our estimates,"
Mahaney says." "Online: Where The Growth Is" BusinessWeek (December
26, 2005) http://www.businessweek.com/magazine/content/05_52/b3965432.htm.
One analyst has predicted that Google will reach $600 before the end
of the year. "Investment bank Piper Jaffray & Co. predicted in a Jan.
3 research note that the search kingpin's stock would climb to $600
before year-end." There are many other opinions, however. "'The
stock is reasonably priced right now,' says Scott H. Kessler, an
equity analyst at Standard & Poor's, which has a $420 target price on
it. 'A lot of people are not cognizant of the many risks and
negatives related to Google.'" "'I wouldn't be surprised to see
Google hit $500 in the next 18 months,' says Ken Marlin, managing
director at investment bank Marlin & Associates." "Google: $600 or
Bust?" by Ben Elgin, BusinessWeek (January 4, 2006)
http://www.businessweek.com/technology/content/jan2006/tc20060104_547928.htm?campaign_id=search.
"And we're very bullish on Google (GOOG), despite its meteoric rise.
We got into the stock early, when it was $98. We think Google will fly
to $500 in 12 months." "The Rewards of Concentration" BusinessWeek
(December 23, 2005) http://www.businessweek.com/investor/content/dec2005/pi20051223_4137_pi057.htm?campaign_id=search.
I suspect that investor sentiment is going to play as much of a role
in Google's stock price this year as will its financial performance.
The key things to watch will be not only does it make its quarterly
numbers, but does it continue to exceed them by a significant amount.
If it does not, I think it is much less likely the stock will reach
$550. While considerable growth is expected in the online advertising
market, Google will also need to demonstrate an ability to generate
revenue from other sources. Unlike Microsoft, it does not have a
virtual monopoly with high switching costs. There is no guarantee it
will be able to always provide the best search technology, although
the company certainly has made every effort to attract many smart
people. The company is facing lawsuits in response to its digital
library initiative, its effort to purchase traditional magazine
advertisements for its advertisers has not been well received so far,
and it is unclear what the financial benefits of its new relationship
with AOL and its desktop software package will be. One analyst
suspects that the Google Pack is designed to get Google a foothold on
users' desktop that it can control. "The Google Hack Gotcha" by Rob
Hof, BusinessWeek (January 7, 2006)
http://www.businessweek.com/the_thread/techbeat/archives/2006/01/the_google_pack.html?campaign_id=search.
It remains to be seen what the company will do to monetize it.
If Google can gain some strong financial results from these newer
activities, or if its search advertising business grows faster than
anticipated, then the stock may very well hit $550 whether it is truly
justified by the company's long-term business prospects or not. At
$600, the company would be the 10th most valuable United States
corporation by market capitalization. While it is a great company
with very useful products, I question if it is truly that valuable in
its current incarnation.
Personally, I would feel better about the company if it had a more
diverse revenue stream. "Google is estimated to generate 99% of its
$6 billion gross sales last year from a single fledgling concept --
selling relevant text ads alongside pages of search results and other
Internet content." Although the company's market share may be as high
as 64%, the market's growth rate is expected to slow considerably to
between 20 and 40% a year beginning this year. To maintain its
current growth rate on online advertising sales alone, Google would
have to grow its market share significantly, and I question whether it
can do that. I am also concerned that investors have come to expect
sizable upside surprises each quarter, and I question whether the
company will be able to continue to outperform by such a substantial
amount when analysts appear to be getting more aggressive with their
estimates.
In summary, I think it is possible that the company could reach $550
per share, but I think it will only do so if it continues to exceed
quarterly earnings estimates by a significant amount. Furthermore,
for any such valuation to be justified, I believe the company needs to
demonstrate its ability to diversify its sources of revenue. I hope
this analysis has been useful to you, and I encourage you to review
the cited materials for additional information you may find helpful.
Sincerely,
Wonko
Additional sources:
"Putting The Screws To Google" by Jon Fine, BusinessWeek (January 23,
2006) http://www.businessweek.com/@@pYB6wYQQAuVhDg0A/magazine/content/06_04/b3968031.htm
"Can Google Go Glossy?" BusinessWeek (December 12, 2005)
http://www.businessweek.com/magazine/content/05_50/b3963130.htm
"Google's Great Works in Progress" by Burt Helm, BusinessWeek
(December 22, 2005) http://www.businessweek.com/technology/content/dec2005/tc20051222_636880.htm |
