Apparently, Wall Street hasn't learned from its mistakes. As I write this, the stock market claims that $114.7 billion is a fair price to pay for Google
That $114.7 billion is a tremendously big number, especially when compared to Google's actual financial performance. Over the past four reported quarters, for instance, Google has taken in a mere $7.14 billion in revenues and earned $1.69 billion. That gives it a price-to-sales ratio of 16.1, and a price-to-earnings ratio of 67.9.
Looking at those numbers from a different perspective, Google has a revenue yield of about 6.2% and an earnings yield of about 1.5%. For perspective, thanks to their recently raised dividends, owning a unit of Cedar Fair
Those valuation ratios would be one thing if Google's revenues were closer to $71.4 million (1% of the current amount) and it had a gigantic market to capitalize upon. At its current size, though, Google is already a huge fish in its primary pond. Its future is starting to get constrained by the overall size of its market. When the market starts valuing a large company like Google as if it were a rapidly growing microcap, it's a sure sign that something is out of whack.
What about Google's growth?
There's no question that Google's growth over the past few years has been phenomenal. Yet the bigger a company gets, the tougher it gets to sustain rapid year-over-year growth rates. In Google's case, this means it's about to hit a brick wall. Here's why:
- According to its most recent quarterly filing, 98.8% of Google's revenues come from advertising.
- Late last year, JMP securities estimated that global online advertising will reach $65 billion by 2010.
- Google's profit margin over the past four quarters worked out to about 23.7%.
If we make a few generous assumptions and claim that Google will:
- Capture half of the world's anticipated online advertising revenue in 2010.
- Maintain a steady proportion of its revenue from other sources.
- Improve its profit margin to 25%.
... those assumptions would indicate that Google could potentially be earning some $8.2 billion in 2010. That means Google is currently trading at around 14.1 times its potentially anticipated earnings for a period that ends some 4.5 years from now. That's absurd.
First, it presumes a whole lot of things will go right for Google. Second, it presumes that Google's profit margins will actually increase as its market expands. That'd be fine if it were a monopoly, but with rivals such as Microsoft
In conclusion ...
Google is priced to perfection, as if its business will continue to grow exponentially, unencumbered for years to come. With such high expectations baked into its stock, there's only one way for the market to be surprised -- downwards. As an investor, you can buy many stocks far more cheaply than Google. Or, if you'd rather, you can find ones that will pay you so much better instead. Either way, your money has a far better chance of sticking with you if you focus it on the reality of cold, hard cash than the pie-in-the-sky potential driving Google's current stock price.
Think you're done with the Duel? You're not! Go back and read the other three arguments, and then vote for a winner.
Cedar Fair is an Income Investor selection, while Microsoft is an Inside Value selection. Whatever your investing style, the Fool has a newsletter for you.
At the time of publication, Fool contributor and Inside Value team member Chuck Saletta owned shares of Microsoft. The Fool has a disclosure policy.
