I have been looking at Google (GOOG) for the past several months as an investment opportunity. It's very apparent to me that this company, with the potential it has to offer, is trading at a discount to what it is presently worth. Let me explain.
First, let's talk about Cash. Companies with significant cash don't get credit for it and I think this is where long term investors get awarded for truly recognizing the value of the cash on the balance sheet. Google has $84/share of cash on its balance sheet. This means that at the current price of $508 as of the 05/17 close, you are effectively paying $424 for its earnings power. Now, this is not precisely how it works, but let's give it some leeway and say you are paying $445.
My model on Google (available on request, contact me) yields me earnings of about $28.50/share for this year (given Euro at 1.15 avg. in 2010), approximately $33/share (Euro at parity) for 2011 and $37.20/share (Euro at parity) in 2012.
What are the top assumptions I made and what assumptions did I not make?
My top assumptions include:
1. Desktop search continues to grow with increasing ads being placed on the internet, more users come on board the internet around the globe, in emerging markets, for example China.
2. Google maintains its search market share.
3. Google gets significant revenue from mobile search despite iAd.
4. Google establishes itself as a strong brand in India, Brazil, Turkey and other emerging markets, driving growth outside the US.
Assumptions I did not include:
1. Google could find another major/minor revenue driver.
2. Google could enter China again.
3. Google could start profiting from Android.
If you go through these assumptions, I feel that the assumptions I have made are relatively safe and I expect them to materialize. The assumptions I did not include are like a free call option where Google's stock engine could really power up.
So let's turn to valuations. Now there are several things we can look at, but let's start at the very basic - P/E. Given my assumptions and my estimates of earnings, the P/E ex cash for 2010, 2011 and 2012 are 15.6, 13.5 and 12.0. I don't believe in comparing valuations to historic multiples because it doesn't really mean anything, but when you look at current multiples, they are attractive.
I don't think Google is fairly priced given the potential it holds. Another major revenue driver can power this stock higher. A lot of overhang exists but I think this should clear relatively soon. It's only been 4 months that Google has been lagging the market.
Catalysts include: Earnings and new product announcements. I think Google will be relying on its earnings to prove to investors that this company still has the mojo, and I believe it will. New product announcements will only be catalysts if Google proves it can make money in places other than search.
I believe Google is a fantastic opportunity for a long term investor and offers an excellent entry point into a company of innovation and excellence.
Price Target: $870 Jan 2012