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Google – overpriced? November 29, 2006

Posted by sk in Computers & Internet, Google, Microsoft, Technology and Software.
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Dave Winer says Web Bubble Burst 2.0 will come about when Google’s stock crashes and that we’re safe as long as Google is doing well. Scoble believes there’s nothing that can stop Google. Even if the domestic market stops growing, he says there is a lot of scope for growth in international markets and as long as that potential exists, Google will continue to grow at alarming rates. He further goes on to say that Google is in the same position that Microsoft was in 18 years ago and we all know how far Microsoft has come.  I guess he’s right too. For a long time Microsoft had just one source of revenues – Windows. Even now, about 90% of their revenues come from Office and Windows. Most of Google’s revenue comes from advertisements.

Speculators are having a field time predicting their next move. I don’t want to go down Will-Google-Get-Bigger-than-Microsoft lane here. There are many other bloggers who are devoting ample time, energy and resources in putting together those arguments… oops… posts!!! With due respect to their endeavors, let me proceed to my main point here. With Google’s shares trading at $489.50 currently, I have been obviously intrigued. Is it overpriced? Of course, yes! Duhh… stupid question??? So how overpriced is it? Is it overpriced enough to bring the entire market crashing down? If the prices were to climb up to $1000/share, then yes. Speculators would try to sell their shares in lots and cause rapid fall in share prices. Obviously, for this to happen, the volume of the stock controlled by these traders need to be substantial enough to cause any change in the price. But at what price will this happen? I don’t know! My guess is as good as yours. But I do feel that Google has the potential of bringing about a bubble, if not another crash.

I tried to calculate the Intrinsic Value of Google’s stock. This would tell me how much the stock may be worth depending upon the current earnings of the company. Even though this is not a definite yardstick for quantifying whether the present market price is good for investment purposes or not, it will definitely give you a good idea regarding your position. Of course, all these calculations require a great deal of discretion on the part of the investor to make a rational and educated judgment.

So how do I achieve this task? Simple! I followed the time and tested rule of using the Earnings Per Share (EPS) and the annual returns of stocks. For the annual return of stocks, I used the Geometric Average of Stock Returns from 1929-2005. This was around 9.69%. I know that this is not a precise figure, but this is the closest to what I want to measure.

Okay, so here is the actual calculation. PRECAUTION: Read the next few lines at your own risk and PLEASE PLEASE do not use swear words when you see the actual figure!

Intrinsic Value= EPS (2006)/Annual Return

= $7.68/.0969

=$79.25!!!!!!

I got the EPS value from Reuters Website. Yes, $79.25 only!!!!

Hmmm….do you want to invest now? I still would… only if I had the money!

(with inputs from cotton)

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Comments»

1. parmanu - November 29, 2006

“..(with inputs from cotton) ..”

ahh…no wonder this post is not making any sense to me..

you started with a number around 500…went as high as 1000, did something unholy and ended at 80 dollars..

*shudders*..these financial people…!

2. Tabula Rasa - November 30, 2006

Yeah!
But to be honest….is EPS only way to measure the value of investment??
And also, current price is an indicator of future earnings. If you willing to use geometric average of market growth. Would consider using Geometric Average of google’s income??
With google, there are guys who think google will eventually have flat growth curve and end up as good company and there are guys who think google will end up with greats!!!
I believe in later.

3. Cotton - December 1, 2006

EPS is not the only way to measure the value…I said that it is one of the many methods that you can use…
Current price is not the indicator of future earnings. You would be in the same position knowing today’s price as you would be by knowing other historical prices.. (Efficient Market Hypothesis). This is because all known information has already been embedded in the current price. So how can it possible act as an indicator of future earnings?
I didn’t use the geometric average of “market growth”. I used the geometric average of historical stock returns. There is a big difference. How can I possibly use the market growth average to find the intrinsic value of a particular stock? It’s not possible. So..why would I use the geometric average of google’s income? This would amount to using historical prices to predict future prices again..which goes against the hypothesis.
Yes, I agree that Google will eventually have a flat growth curve..it is the case with every other company as well. Right now it is experiencing an abnormal growth rate… which will turn into a normal growth rate after a couple of years. I don’t know exactly after how many years… we need to wait and watch. Infact, most of the value of the stock is due to the PVGO (Present Value Growth Opportunities). I can show you the deduction if you want. I wanted to put it up in my blog..probably I will by this weekend. As much as $400 out of $500 approx. is due to the growth rate of the firm. It may be overpriced, but yes, it is definitely growing at a staggering rate for now.
It will be interesting to see when the stock split will be announced! I guess the prices will climb up again after the split is announced.

4. sk - December 1, 2006

What I don’t understand about Google is, who clicks on those text ads. I use Google search all the time but not once have I clicked on the ads. I had asked some other people about it and most of them don’t either. Now Google is not going to release these details but I’m interested in knowing how much of their revenue comes from their searches and how much from ads on third party sites. My guess is that typo-squatting and click-fraud constitute a significant portion of their revenues.

There is tremendous pressure on Google to continue growing and beating Wall Street estimates. 2-3 bad quarters may be all that it takes for a Web 2.0 bubble burst. For the record, I don’t mean Google will fold up or that it will collapse. In fact, Google will remain a major force in the industry. The smaller companies will bear the brunt of this.


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