Is Google Cheap?

The Google stock has fallen back to $550 from over $600 (a level I have already said I’d buy at). Of course the price may continue to fall for at least three reasons:

1/ Obama is talking about breaking up the biggest banks and has spooked the whole market
2/ Google has threatened to leave China altogether following some instances of hacking and a continued censorship policy
3/ The founders of Google, Sergey Brin and Lawrence Page, have announced that they will sell 5 million shares each for ‘liquidity and diversification’ reasons over the next 5 years

Right now, GOOG is trading at 26 times 2009 earnings which would be expensive if it weren’t for their relentless growth. In three years (and the biggest post-war recession) Google’s revenue has grown from $16.5billion to $23.6billion. 43% growth in three years (around 12.5% per year) in the midst of a recession is impressive by anyone’s standards. Their cash pool has grown to approximately $25billion. They recently acquired AdMob for $750million.

If you subtract this cash from their market value, Google is actually ‘only’ trading at 23 times earnings.

But what is Google worth? This is very difficult to say with any certainty or ‘margin of safety’ as Warren Buffet would call it. Probably why he doesn’t own Google stock in Berkshire Hathaway. Will someone invent some technology that will make Google’s dominance of the Internet obsolete? No-one knows!

However, at the same growth rate of the past 3 years, Google will be earning twice as much in 6 years. Chances are, with the explosion of mobile Internet, Google will grow even faster than that. Google themselves say that mobile search will be bigger than the PC search. Another good reason to predict that Google will at least double in size within the next decade then.

Another way to look at the value of Google is to try to predict the total future earnings of the company. How long will Google exist as a profitable business for? Lets look at cumulative earnings:

10 Years (12.5% growth rate p.a.) = $365 per share
15 Years (10% growth rate p.a.) = $645 per share
20 Years (8% growth rate p.a.) = $929 per share
30 Years (5% growth rate p.a.) = $1340 per share

… I have reduced the average growth rate as the time period expands to be conservative. Remember the 12.5% growth rate has been established from the past three years and was achieved in a recession.

I think it is not unrealistic to assume that Google’s brand and cash pile will allow it to remain dominant for 30 years, especially as it is now aggressively moving into the mobile arena. Therefore buying Google at today’s price (around $470 per share when you discount the cash it has) is potentially much less than a third of Google’s true value.

If you can go long, and I mean loooong (>10 years) I think there is a fortune to be made from Google stock. You just need to be patient and ignore the noise.

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