How Much Is Google Worth?
With a market cap of $250 billion, Google (NASDAQ:GOOG) is the largest internet information provider in the world. The company primarily derives its revenues from online content advertisement. As an internet & software conglomerate, the company is battling several other giants in the business. Nevertheless, thanks to the growing number of internet users, Google's revenues experienced an annualized growth rate of 30% in the last 5 years. I think the stock is still cheap based on fundamental metrics and my FED+ model supports this notion.
As of the time of writing, Google stock was trading at $767 with a 52-week range of $480 - $770. Trailing twelve month P/E ratio is 22.76, and forward P/E ratio is 15.57. P/B, P/S, and P/CF ratios stand at 3.9, 5.8, and 15.9, respectively. The 3-year annualized revenue and EPS growth stand at 20.3% and 30.8%, respectively. Operating margin is 30.5%, and net profit margin is 25.7%. The company has a low debt-to-equity ratio of 0.1. Google does not have a dividend policy yet.
Google has a 3-star rating from Morningstar. While its trailing P/E ratio is 22.6, it has a 5-year average P/E ratio of 30. Thus, Google is trading well below its historical P/E ratio. Out of 9 analysts covering the company, 6 have buy, 2 have outperform, and 1 has hold ratings. Wall Street has diverse opinions on Google's future. The bottom line is 15% growth, whereas the top-line growth estimate is 48.9% for this year. Average five-year annualized growth forecast estimate is 19%.
What is the fair value of Google given the forecast estimates? We can estimate Google's fair value using discounted earnings plus equity model as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look intimidating for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Valuation
Historically, the average return of the DJI has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($33.73 + $49.30) / 2 = $41.52
Wall Street holds diversified opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 19%. Book value per share is $197.96.
The rest is as follows:
Fair Value Estimator | ||
V (t=0) | E0 | $41.52 |
V (t=1) | E0 (1+g)/(1+r) | $44.51 |
V (t=2) | E0((1+g)/(1+r))2 | $47.71 |
V (t=3) | E0((1+g)/(1+r))3 | $51.15 |
V (t=4) | E0((1+g)/(1+r))4 | $54.84 |
V (t=5) | E0((1+g)/(1+r))5 | $58.79 |
Disposal Value | E0(1+g)5/[r(1+r)5] | $534.48 |
Book Value | BV | $197.96 |
Fair Value Range | Lower Boundary | $833 |
Upper Boundary | $1030 | |
Lower Potential | 8.5% | |
Upper Potential | 34.3% |
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for Google is between $833 and $1030 per share. While the stock made a remarkable gain of almost 50% in this year alone, it has at least 8.5% upside potential based on analyst estimates. Moreover, the stock has 34.3% upside potential to reach the upper boundary of its fair-value range.
Peer Performance
While there are many companies in the IT and software sectors, Facebook (FB), Microsoft (MSFT), and Yahoo (YHOO) are the closest competitors in the online advertisement space.
Based on the trailing and forward P/E ratios, Microsoft is the cheapest one among this group. Microsoft's single digit P/E ratio is one of the lowest in the technology field. Microsoft is also the only stock that offers dividends.
Microsoft | Yahoo | |||
Trailing P/E | 22.7 | 116 | 14.9 | 18.1 |
Forward P/E | 15.6 | 33.7 | 9.05 | 13.9 |
P/B | 3.9 | 3.4 | 3.77 | 1.54 |
Yield | - | - | 3.08% | - |
Debt/Equity | 0.1 | 0.05 | 0.18 | 0.01 |
All of the above mentioned companies have solid balance sheets with only negligible amounts of debt. Obviously, Facebook is the most expensive stock in this group. With a triple digit P/E ratio, Facebook still looks expensive, even after losing almost 50% of its market cap since IPO. Yahoo looks like the cheapest stock in terms of P/B value, but I would exercise caution when assessing high-tech companies based on P/B ratios. With a trailing P/E ratio of 18.1, Yahoo ranks somewhere in the middle of the above group in terms of valuation.
Recent Events
Besides fighting with the industry giants on several fronts, Google has recently engaged in a fierce battle with Vringo (VRNG). Vringo, a small cap company that trades on AMEX, has filed a lawsuit against Google due to patent infringement. Vringo did not obtain this patent itself, but it acquired it in July through its merger with the intellectual-property firm, Innovate/Protect. The patents originally belonged to Lycos, which is one of the earliest search engine companies.
Lycos, along with several others, were completely eliminated after Google introduced its own search engine. Thus, this law suit could be targeting the very foundation of Google's business model. AOL has already settled with Vringo. The judge overseeing the case has recently refused to end the case in Google's favor. That decision created is a wide expectation for another settlement between Google and Vringo. However, I do not expect the negative court ruling to have any substantial effect on Google's balance sheet. I think the most likely scenario is a bold take-over offer from Google to acquire Vringo. After all, Google is a Goliath compared to Vringo.
Summary
Google is the center of innovation. The search engine titan obviously has its moat in its primary business. Google is not only one of the best places to work, but given its profitability, it is one of the best places to put your money. As the number of internet users keeps going up, I expect Google's profits to rise. Analysts' expectation of 19% earnings growth is highly attainable given the company's past growth record.
While the trailing P/E ratio of 22.7 is beyond my safety level of 20, the forward P/E ratio of 15.6, current ratio of 3.84, and debt to equity ratio of 0.1 are strong green flags. Based on 19% EPS growth estimate, my FED+ Fair Value range for Google is $833 - $1030. Several analysts also agree with me. Capstone Investments just upgraded its target price to $910. Conaccord Genuity and Argus have target prices of $850 and $875, respectively. I am expecting other institutions to follow the upgrade trend.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (16)
If so, its future would be very, very well secured and a big threat to MSFT and its windows..