A little over a year ago on this blog, way back in October of 2004, I put a $400 price target on Google. It was partly to be provocative, but it was also because too many people were underestimating the power of the search-advertising company’s business to suck in profits. Now that Google’s share price is within a paperback book (i.e., $10) of that $400 target, it’s time to muse where Google shares go from here.
While I’ll teasingly hold specifics for an upcoming post, just to get things going here is Joseph McNay of Essex Investment Management on the subject from the weekend issue of Barron’s:
Talk about Google’s valuation.
From my point of view, it is reasonably valued. At some point, it won’t be. But if it maintains its current growth rate, it is reasonable. It has very strong revenue growth. It has a very strong advertising component and could earn $8 or $10 a share. That’s cheap, and it makes me want to continue to own the stock, which I am doing. Its full capitalization is over $100 billion. Its revenue growth has been running 95% to 100% every quarter for the last number of quarters. The consensus earnings estimate for next year is about $8.50, and my guess is that is understated. Earnings could be $9 or $10 a share. At 35 or 40 times earnings, for a company growing at this rate and No. 1 in its sector, Google, frankly, is cheap. I watched IBM, growing at 15% a year, sell at 20 times earnings at the bottom of markets and 60 times at the top of markets for many years in the 1960s, just to give this a frame of reference.
Any other historical parallels to Google?
Xerox sold at 50 to 100 times earnings for many years and dominated its market. Polaroid sold at 30 to 75 times earnings for long periods. Apple is another great case in point, and you could even add Wal-Mart, which didn’t have that fast a growth rate but had a very consistent 25% to 30% growth rate and sold at 30 to 40 times earnings for a very long time. In other words, if a company is so dominant and has all the right characteristics, a multiple of 30 to 50 times earnings is absolutely common. One period we could be emulating, to a small degree, would be the one-decision growth-stock era.
The Nifty Fifty? Omilord, right? Well, maybe not, as McNay astutely points out using a sociological explanation of buyside investor behavior:
Most of the young people in the business — the research analysts and the portfolio managers — who entered the business in the late ‘Nineties are now scared to death of multiples and valuations because they saw everything get cremated and “value” become the place to be. Well, the value market is played out, and the value stocks and the growth stocks are priced, in many cases, not far from each other. Now you are beginning to see the earnings come through in a lot of these outstanding growth stocks, and these young people are going to have to shift as they see that Apple, for instance, or some of the biotechnology companies are continuing to grow. People will start to pay for these stocks.
He may or may not be right — there is more than buyside behavior involved in paying up for Google and its ilk — but McNay makes a very good point: There is a new generation of professional investors out there who have spun 180 degrees and become terrified of growth. That is worth noting.