Is Google Undervalued?

Google (GOOG) announced stronger than expected third quarter financial results yesterday (see conference call transcript).  This resulted in a US$13.85 (4.08%) lift in the share price to close at US$353.02 – and more in after-hours trading.  This is still less than half the 52-week high of US$747.24. 

This bodes well for $GOOG in volatile market conditions.  We decided to have a look at $GOOG with the Valuecruncher interactive tool to place an estimate on the intrinsic value of the company using a discounted cash flow valuation.

Valuation

Valuecruncher produces a valuation of US$416.73 for $GOOG.  This is a current valuation (an estimate of intrinsic value) not a target price.  This valuation is 18.0% above the current share price of US$353.02. (See the Valuecruncher valuation model of $GOOG with interactive assumptions.)

Assumptions

In 2007 $GOOG had annual revenues of US$16.6 billion and an EBITDA margin (profits) of 40.7%.  Reuters aggregates 26 analysts covering $GOOG and these have mean estimates of 2009 and 2010 revenues of US$22.4 and US$27.9 billion respectively. 

For our analysis we have used US$22.0 billion in 2008, US$27.0 billion in 2009 and US$32.5 billion in 2010.  We have forecast EBITDA margins remaining flat at 40% to 2010.  We have estimated capital expenditure in 2008 at US$3.075 billion rising to US$3.75 billion in 2010 and at US$3.25 billion beyond that.  Capital expenditure dropped dramatically in quarter three to US$452 million from US$697 million the previous quarter.  We don’t believe that capital expenditure will remain at the current level (Q3).  All of these assumptions can be amended in the Valuecruncher on-line valuation model to adjust the valuation.

Other Model Assumptions

Discount Rate: 11.0%.  We believe the discount rate is in the 9-11% range.  We have used the upper end of this range to reflect the uncertain market conditions that $GOOG signalled in the announcement.

Terminal Growth Rate: 6.0%.  The US economy grew at an average of 3.6% over the last five-years.  $GOOG showed that while growth is slowing there is still more to come.

Our analysis incorporates the cash the $GOOG balance sheet – Valuecruncher calculates a net debt number.

Based on our analysis and assumptions, the current share price is at a discount to intrinsic value.  Play with our assumptions – what does your analysis say?

Disclosure: None