Saturday, February 25, 2006

Is Google Overvalued at $377? Feb 25, 2006

There is no doubt that Google is an interesting company. Google has superior technical staffs, Internet advertising is growing dramatically at the expense of television and newspaper advertising and Google has dominant market share in the search business.

So, what is so great about this company?

Net income:
It is growing its earning at a very, very high rate. Net income increased by over 200% from $399M (2004) to $1297M (TTM). Very impressive indeed.

Gross Margin (TTM): 57.2%
Net Margin (TTM): 24.7%
ROA (TTM): 21%
ROE (TTM): 23%

Without doubt, Google is a strong and admirable company. Bill Miller, one of the legendary investment managers, believed that Google is undervalued and Google should be valued above $200B, which are 2X current value. (Jan 20, 2006; money.CNN).

But, is it a good buy?

There are a couple of ways to value Google.

Google Valuation, Method 1:
Comparison between other Online / Internet companies:

Price/Sale Ratio
Google = 21X
Yahoo = 9.7X
IACI = 1.3X

Google = 75X
Yahoo = 26X
IACI = 11.7X

Even by relative comparison, Google seems excessively priced; it has 2X higher valuation than Yahoo and more than 19X higher than IAC/InterActive Corp, based on price/sale ratio.

Google’s Valuation, Method 2:
Fundamental analysis on Income statement, Balance Sheet, Cash Flow Statement, etc.

Market Cap = $111B (Feb 24, 2006)

Enterprise Value (TTM)
= Market Cap + Total debt (interest paying) – Cash
= $111B + $0.55B - $7.6B
= $104B

Free Cash Flow (TTM)
= Net operating Cash Flow – Net Investing Cash Flow (excluding acquisitions)
= $2.17B - $0.65B
= $1.5B

Enterprise Value / Free Cash Flow
= $104B / $1.5B
= 69X

Earning yield (TTM)
= Operating Income / Enterprise Value
= $1.75B / $104B
= 1.7%

By simple fundamental analysis, Google seems to be excessively valued.

Google’s Valuation, Method 3:
Relative comparison to other similar sized companies.

One of the companies that I want to compare Google to is Berkshire Hathaway.

Market Cap:
Google = $111B
Berkshire = $133B

Price/Sale Ratio
Google = 21X
Berkshire = 1.8X

Google = 75X
Berkshire = 20X

Price/Book (TTM)
Google = 12X
Berkshire = 1.5X

Sales / Revenue (TTM)
Google = $5.3B
Berkshire = $76B

Net income (TTM)
Google = $1.3B
Berkshire = $6.7B

Berkshire has sales / revenue of 14X bigger than Google;
Berkshire has net income of 5X bigger than Google;
Yet, Berkshire only has 20% higher market value than Google.

In conclusion:

By three methods of simple comparisons / analysis, Google seems to be overvalued. Therefore, it is not surprising that Google’s value plunged from $475 (Jan 11, 2006) to $377 (Feb 24, 2006) in a matter of 7 weeks, wiping Google value by $29B! Yep, that’s right, $29B loss in 7 weeks!!

Warren Buffett and Charlie Munger, two of the great investors of our time, sum it up the best.....

Charlie Munger said “Buying great businesses at advantageous prices is very tough." (May 8, 2001)

Warren Buffet said “The critical investment factor is determining the intrinsic value of a business and paying a fair or bargain price.” Also, “It is more important to say "no" to an opportunity, than to say "yes".”

All the best,
Dah Hui Lau (David)

2 comments: said...

Thanks for showing how you did all the calculations. I read this article on and will now read your other articles. Cheers

OceanBlue said...

If Google's profit continue to grow in this rate (200%/year) for 10 year, it will be pow(3,10)*399M = 23.560551 trillion.

i.e. The whole U.S. stock market will be eclipsed by Google (given that the other companies won't grow as fast).