What's Google's Value?

In his monumental work, The Theory of Investment Value, John Burr Williams says that the value of any company is equal to the present value of the cash that can be taken out of the business.

The book provides investors with the basic framework to value a business: Determine how much cash a business generates after it pays the bills, then discount the cash back to the present. To demonstrate this process, let's examine two different companies in vastly different industries. I've simplified things considerably for this article, but the essential framework remains intact.

Valuing a megasite
Since Google's (Nasdaq: GOOG  ) phenomenal growth is widely publicized, let's see what the search giant might be worth. In the four-year period of 2003-2006, Google generated free cash flow -- operating cash minus capital expenditures -- equal to:

Year

Free cash flow

2003

$218 million

2004

$658 million

2005

$1.62 billion

2006

$1.67 billion

During the first three quarters of 2007, free cash flow came to approximately $2.4 billion. So let's assume that for 2007, free cash flow comes to $3.2 billion -- giving Google credit for another spectacular quarter.

Without any calculation, you can easily see that Google's free cash flow growth over the past five years has been mind-boggling -- and that those growth rates are not sustainable as the numbers get bigger and bigger. Nonetheless, let's assume that Google can grow free cash flow by 25% for three years, and 15% for years four and five. Free cash flow will look like this:

Year

Free Cash Flow ($billions)

PV of FCF (10%)

2008

4.00

3.63

2009

5.00

4.13

2010

6.25

4.70

2011

7.18

4.90

2012

8.25

5.12

Let's suppose that a company like Google would sell for $165 billion in 2012, or about 20 times free cash flow (an absolutely rich multiple, but hey, it's Google, right?). That yields a present value (PV) of about $102 billion today. Add this sale value with the present value of the cash flows above, and you get an approximate intrinsic value of $124.5 billion.

One of the key variables in this valuation is the discount rate used. As a personal rule of thumb, I will generally use 10%, since that's been the market's historical return. However, I will adjust it, given the nature of the business involved. To keep things really simple -- though highly unlikely -- we'll suppose that Google maintains the same outstanding share count in 2012 that it has now, about 312 million. Simple division implies a value of $399 a share. If more shares are issued, the value decreases. It appears that at the current price of $702 a share, investors are considering that Google can grow free cash flow at 50% a year! With the company's present size, this is wishful thinking. I suspect that the same attitude is being applied to the likes of Baidu (Nasdaq: BIDU  ) and Chipotle (NYSE: CMG  ) (NYSE: CMG-B  ) . These are all excellent businesses, but not attractive investments.

Valuing a minimill
Let's use the same approach for Nucor (NYSE: NUE  ) , an immensely profitable steel company. Between 2003 and 2006, Nucor grew its free cash flow from around $280 million to $1.9 billion, a phenomenal rate of growth in its own right. For the first three quarters in 2007, free cash flow was $1.06 billion, giving us an estimate of $1.4 billion for the full year. To keep it simple, suppose that Nucor can grow free cash flow at 10% for the next five years, and then be sold for 12 times 2012 free cash flow:

Year

Free Cash Flow ($billions)

PV of FCF (10%)

2008

1.54

1.40

2009

1.69

1.40

2010

1.86

1.40

2011

2.05

1.40

2012

2.25

1.40

2012 (sale)

27.0 (sale)

14.0

The sum of the present value of Nucor's cash flows equals $21 billion. Since 2001, shares outstanding have gone from 311 million to 300 million. If you assume that share count won't change in 2012, each share is worth $70, against today's price of $63.

Remember, my assumptions are just that. All the same, it's good practice for Fools to run this exercise on businesses that look intriguing.

Fairly valued further Foolishness:


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