After taking a look at the continued potential in Apple (AAPL) shares, I became curious about valuations across the rest of the tech space. Using the same Buffett-inspired analysis, I crunched the numbers on Internet search titan Google (GOOG).
Google vs. Uncle Sam
Google's trailing twelve-month earnings per share is $29.76. Dividing EPS by the current market price of $643 equates to an earnings yield of 4.6%, which beats the 30-year bond yield of 3.4%. In addition, while a bond yield is static, the 4.6% yield offered by Google grows along with earnings. Based on analysts' projections, the yield could grow 13% annually. If we only used this method, Google would be a buy.
Good Ol' Fashioned Earnings Growth
Another way to look at valuation, and the one most likely employed by a majority of investors, simply takes the current EPS of $29.76 and multiplies it by analysts' five-year growth projection of 13%, which equals earnings per share in the fifth year of $54.83. Multiply this by the current P/E of 21.6 to get a price target of $1,185. If we were only interested in entering a position offering a CAGR of 15%, we could discount 1185 back to the present and only buy Google under $590. Technically speaking, we could get that opportunity soon as Google has closed the gap from a high volume sell-off and looks set to test back to the January lows on general market weakness.
Given that Google's growth has been slowing however, we may see its multiple contract and this poses a risk to the forecast. Using a more modest P/E of 17 (the multiple investors are paying for Apple, the target becomes $932 and requires an even better entry to earn a CAGR of 15%.
The Incredible Expanding Coupon
The final and most eye-opening way Buffett values a stock is by viewing it as an equity/bond with an expanding coupon. Looking at Google in this fashion, the initial investment of $643 a share would be seen as a bond yielding 4.6% (just like the first example above), but rather than grow at the EPS growth rate, the "coupon" would increase at the rate management is growing the equity base. This is where return on equity comes in.
Google's shareholders equity value, or book value, is $178. Dividing by the EPS of $29.76 equates to a return on equity of 17%. It follows that five years later, we can expect a book value of $390 ($178 grown at 17% annum). Multiply 390 by the ROE of 17% and you get projected earnings per share of $66. Multiple $66 by our adjusted P/E expectation of 17 and you obtain a five-year price target of $1,122.
My five-year price target for Google is $932-$1,122 representing a CAGR of 8% and 12%, respectively from current levels. Though I love the company's advertising cash flows, I would only be a buyer on significant weakness, the kind that would take shares back to 2011 lows under $500.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.