Google's Valuation: PEG Is The Best Metric

| About: Alphabet Inc. (GOOG)

Here's something you won't read too often: Google (NASDAQ:GOOG) "lost money" in 2006. According to its cash flow statement, just over $330 million flowed out, despite just over $3.0 billion in net profit for the year.

Those focused on the cash flow statement probably helped to push the shares down since Google reported earnings January 31. Yet a closer look at the specifics show that the culprit was not operations. Far from it. Operating cash flow improved to $3.6 billion from $2.5 billion, an increase of 45.6 percent on the year.

The real bleeding came from investing activities and it's a problem investors should love to have. Google spent a whole lot of money — $6.9 billion, to be exact — on growing business for the future. That's a 105.4 percent increase compared with a $3.4 billion investment in 2005.

We'd wager that not all of that will pan out to higher growth in the future — even for Google — but evidence that Google management is spending to grow the company is heartening for long-term investors looking at that price-to-earnings ratio of 50.45 right now.

And about that P/E: On the surface, it's a huge number. The S&P 500's average P/E on Wednesday stood at 20.80.

But take a look at the range. Valero Energy Corp. (NYSE:VLO) is part of the S&P 500. At 6.62, its P/E is lowest of companies with positive earnings. At the other end of the spectrum, Advanced Micro Devices (NASDAQ:AMD), would have a P/E of 1503.8, if it had a meaningful P/E.

Whenever we've looked at Google's value in the past, we've compared it to Yahoo Inc. (NASDAQ:YHOO), and we shall continue to do so. Yahoo's P/E is 54.44 today.

In a vacuum, P/Es don't tell you much without a sense of future growth expectations, which we measure with a price-to-earnings-to-growth ratio (NYSE:PEG). The analysts expect Google's growth rate over the long term is 35.3 percent, on average. The same figure for Yahoo is 26.8 percent. Assuming the analysts are accurate, this would place Google's PEG ratio at 1.4, and Yahoo's at 2.0. It seems Google's post-correction value compares favorably to YHOO shares.

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