Will Google Cross $300?
- Jun 10, 2005
- admin
- Investing
THEY’RE PLAYING OUR SONG!
You know the tune.
The one where you’re supposed to dance around the room with other
investors right up until the time the music stops.
And as soon as the music stops, everyone in the room – yourself
included – has to rush to sit on a chair.
But the room is one chair short.
That means you’ll either have to toss the Barbara Bush lookalike
off the chair or you’ll be left standing yourself.
And when it comes to investing those who are left standing are left
broke.
Which brings me to the subject of Google (SYML GOOG), the company
that can do no wrong.
In fact, Google has been on such a tear lately that while its stock
has flirted with the $300 per share mark everybody from Microsoft’s
(SYM: MSFT) lunatic Chairman Bill Gates to those savvy analysts
on Wall Street will have you thinking that Google is indeed the
best investment ever.
And why not? Everybody loves a money maker.
But a simple reading of history – both recent and far past – would
tell you to be afraid.
Be very, very afraid.
Let me explain.
I love Google. I use the service every single day. You might call
me a “Google-Ho.”
As far as search goes I’ve never seen better.
But to explain how I could love the product and hate the stock
(almost the exact opposite of what Peter Lynch touts), I have
to use an analogy.
Let us assume that the opportunity has presented itself for you
to buy an Internet search company.
Thatís right.
Remember that college roommate of yours?
Yea, the one who you thought was drinking every night?
Well, instead of drinking he was programming.
And you just got the call to buy his entire search engine outright.
Weíll call it Joeís Search Engine.
You debate the offer.
On the plus side, the search results are always relevant and
the website has a great reputation with advertisers.
In addition it almost seems that the business runs on autopilot.
Now, Joes Search Engine has been in business for over 5 years
and happens to do $1,000,000 in sales each year.
(Follow me here folks)
It also happens to be profitable, bringing $100,000.00
per year in earnings.
In a fair value private transaction, it could be argued
that Joe’s could sell for 3-4 times earnings, which would
be between $300,000 – $400,000.
In other words, it would take you 3 – 4 years to get
your money back.
Now letís assume that the Joe, the owner of the search
engine, wakes up one day and reads that Google is selling
with a P/E of 150.
That means that the company is selling for 150 times
its profit.
Joeís shocked.
Stunned may be a better word.
Why?
Because he thinks his search engine is better. In fact he
KNOWS it’s better.
So Joe – in his infinite wisdom – calls you and tells you
the deal is off.
He wonít sell for anything less than 150 times earnings.
Thatís $15 million dollars.
You think about it for a moment.
If you pay $15 million for Joeís Search Engine it would take
you 150 years to earn your money back.
Thatís a long time even for the most patient investor.
Now back to Google.
Google earned close to a whopping $400 million in 2004.
Now lets assume that they grow their profits at an annualized
rate of 30% per year for the next 5 years.
Why only 30%?
Because companies like Time Warnerís AOL (SYM: TWX) are
waking up from their comas and launcing their own pay-per-click
services (where Google makes most of their money).
Microsoft already started doing it.
And when your two biggest customers start replacing you that
can be a bad thing.
Or two other young men from some school will invent
the next new-new thing in search (who even heard of Google
when Yahoo (SYM: YHOO) reigned supreme in the 90ís?).
What Iím trying to say folks is that profits like this bring
big competition.
And big competition reduces prices.
Lower prices = lower profits.
But thatís another story.
Back to Google again.
Anyway, $400 million in profit growing at 30% annually during
the next 5 years means that by 2010 the company will have
$1.5 billion in net income.
And instead of trading at 150 times earnings, the company
now trades with a P/E of 40, which is closer to its internal
growth rate.
If the company is earns $1.5 billion dollars in the year
2010 and trades at 40 times earnings, the company will have a
market capitalization of $60 Billion dollars.
THIS IS ROUGHLY $20 BILLION LESS OF A MARKET CAP THAN IT HAS TODAY.
Folks, by no means am I saying that the stock of the company
will not break $300 or not.
What I’m simply pointing out is that there is a disconnect
between Google the business and Google the stock.
A BIG disconnect.
Especially when you consider that insiders are free to sell their
IPO stock.
Or that Google now has a bigger market value than Ebay (SYM: EBAY),
which nobody seems to be able to even touch competitevly.
Or that the same brokerage firms recommending
Google that are part of the multi-billion research
settlement.
In other words ladies and gentlemen, step away from the dance.
You can walk into another room entirely and play any tune you
want to.
Just stop listening to music played by players.
Remember, you are what you read…
–By Dylan Jovine