Google Hits My $1.35 Estimate

Earlier this week I postulated Google (GOOG) would report Q2 EPS of $1.35. Sure enough, tonight the company reported $1.19 in EPS including $0.16 in options expensing, which took the number up to my target. The stock is tanking after-hours as investors are always looking for more than most growth companies can deliver. Shares are down 6 percent or $18 to $296 each.

It will be interesting to see what the always valuable (read with sarcasm) Wall Street analysts say in the morning, especially after Google management warned on the call that Q3 is a seasonally weaker quarter (which we all know already). I have little doubt we will continue to see immense selling tomorrow morning, but I would expect money managers who still like the story to bargain hunt under $300 and help the stock recover some lost ground by the afternoon.

I still believe the stock will ultimately trade to 50x EPS, or $350 a share, in the next 6-9 months and as a result would not recommend panic selling alongside everyone else right now with the stock sub-$300. Google still deserves at least the same multiple as Yahoo! (YHOO) and eBay (EBAY) if not more.

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12 Thoughts on “Google Hits My $1.35 Estimate

  1. Krish on July 21, 2005 at 9:31 PM said:


    At what growth rate should investor’s be willing to pay for 50x – 60x earnings?


  2. Chad Brand on July 21, 2005 at 9:47 PM said:

    The answer in most cases is you should not pay 50 or 60 times earnings for a stock.

    However, Google is one of the few situations where conventional wisdom doesn’t apply. There are always growth stock managers on Wall Street who target the companies that are growing the fastest. This has proven to be a poor way to invest, but nonetheless, this is their strategy.

    Google is the fastest growing company around that has attained sheer size and market dominance already. For this reason, certain money managers feel they “need” to own it. As a result, the question you need to ask is “How much are they going to be willing to pay?” This will help you determine where GOOG will trade.

    The S&P 500 trades at a P/E equal to 2x its growth rate. This is why a company growing at a 40% per year clip, as Google is now based on 10% sequential growth from Q1 to Q2 2005, can garner a 50x or 60x multiple, or even higher. We’ve seen the same thing with EBAY and YHOO in recent years, P/E’s of 40, 50, 60x because they are the premier growth companies in the tech sector.

    This is why I think GOOG will trade to $350. Not because it is a “great investment” at that price, but because growth managers looking for the fastest growing companies will pay, in my opinion, 50 times the $7 in earnings Google will earn next year given that Google will probably grow between 30% and 40% annually for the next several years.

  3. Anonymous on July 28, 2005 at 1:18 PM said:


    I respectfully disagree with your GOOG valuation (and also many other Wall Street analysts’ valuations) simply because it doesn’t take into consideration the competition that GOOG will face going into 2006. 50x valuations based on estimated earnings growth of 10% each quarter do not take into account the erosion in numbers that competition from MSFT and YHOO will cause to GOOG going into 2006. I still recommend that GOOG is good for trading for the coming two quarters of 2005 (if you can get it below 290$ i.e.). However, is it an investor’s stock at this price? I highly doubt it.


  4. Chad Brand on July 28, 2005 at 1:30 PM said:

    Disagreement is great, after all, that’s how markets are made. If everyone felt the same way about individual stocks, investing would be pretty boring.

    As for whether or not it’s an “investor’s stock” or not, well, I really don’t know what that term means. I just outlined how I see Wall Street viewing Google for the next year or so. Predicting anything past that is too tough for me at this point.

    As for your assertion that MSFT and YHOO will turn up the heat on Google, cutting into it’s profits, I have to disagree.

    First off, Microsoft has been trying to take search market share from Yahoo! for years, even before Google existed. No such luck then, so probably no such luck this year or next year either, despite a new version of Windows due out next year. Unlike prior tactics, MSFT can’t take out competitors by undercutting them on price (free Internet Explorer crushed Netscape), because search is already free. It will come down to technology… never MSFT’s strong point.

    As for Yahoo, Google is doing everything they are today with Yahoo already as the established player in the market. The market for search is growing fast enough that both will continue to grow at healthy rates.

    All in all, the competitive landscape isn;t going to change in a significant way in 2006, as opposed to previous years, in my opinion.

  5. Bill R. on August 3, 2005 at 7:15 AM said:

    Chad, correct me if I’m wrong here. Your argument is, “other people will pay this unreasonable valuation, so I’ll buy it and hope to sell it to one of THEM before it returns to a reasonable valuation.”

    Not that one can’t make money playing the “bigger fool” game, but let’s call a spade a spade. You are buying at significant premium to the stock’s intrinsic value, for a speculative play, based on what you believe OTHERS will be willing to pay, sometime in the next year.

    I think that’s what “anonymous” meant by saying it’s “not an investor’s stock.”

  6. Chad Brand on August 3, 2005 at 7:56 AM said:

    Actually, Bill, that is not what I said. I never said the valuation was unreasonable. I also never said I would buy GOOG at $300 a share. For the record, I paid $170 for my GOOG shares, and sold a large portion at $304 each, as my prior posts have shown.

    The point of my post was to explain to people where I think the stock will ultimately trade, and why that will occur. If you are going to invest in growth companies, you need to understand how growth managers think. That was the point in explaining why I believe they will be willing to pay such high P/E multiples for companies like GOOG. The stock trades at 40x 2006 earnings right now, and growth managers will be willing to pay that price for a company growing as fast as Google is. Those people (the ones who will drive the share price more than the individual investor) do not see the stock as trading at “a significant premium to intrinsic value” and they are not viewing it “as a speculative play.”

    Whether you or anyone else agrees with them is a different story, but it is very important to understand how Fidelity, Legg Mason, and the other large asset managers approach their jobs when trying to swim with the bigger fish in the sea.

  7. Bill R on August 3, 2005 at 4:25 PM said:


    It seemed to me that you implied the valuation was unreasonable in your opinion when you said “This has proven to be a poor way to invest” and “Not because it is a ‘great investment’ at that price.” Now, when you say you wouldn’t buy at $300, and sold at $304, although you think it will go to $350, you again imply that you think the valuation is unreasonable. After all, if it was reasonable, would you have sold? If it was cheap, wouldn’t you be buying? Your behavior, e.g. not wanting to buy at this level and actually selling “a large portion” of it, implies you think the valuation is unreasonable.

    I see that the CEO of GOOG has sold another $15 million or so of stock this month. I wonder if he thinks its valuation is reasonable.

    I understood the point of your post. It will trade, in your opinion, at a certain level, because of the way certain persons approach their job. This allows us to make a trade based on our opinion of their opinion. Just because they are large asset managers doesn’t mean they can’t be “the greater fool.” According to Peter Lynch, they are probably more likely to play that role because they are large asset managers.

    For the record.
    (1) I think you’re right that it will make higher than it is today. $350? IMO only if it does so before the next quarter’s earnings announcement.
    (2) Bill R. thinks it’s unreasonably valued. But then again, the highest PE in my portfolio is about 12. YMMV.
    (3) Bill R. thinks any trade in GOOG is a “greater fool” trade. Again, lots of people make money on that, even though it’s not my bag, and there’s nothing inherently “wrong” with a “greater fool” trade. But IMO that’s what it is.
    (4) At $170 it probably was a GF trade, too. Markets can remain irrational for a long time, and there are lots and lots of GF’s. They seem to be well rested after March 2000.
    (5) When GOOG has a hiccup on earnings, or even just “meet” expectations in the future instead of exceeding them, it will not be pleasant to be long. They are priced for beyond perfection.

  8. Chad Brand on August 3, 2005 at 5:10 PM said:

    Bill, I understand your perspective. Avoiding GOOG completely is a perfectly logical decision. There have been many times that companies appear to have a dominant position in a rapidly growing market with great growth potential, and still wind up losing all of that very quickly. Netscape comes to mind as a good example.

    Clearly, value investors would shun GOOG at most any price, whether it be the $85 IPO price, $170, or $300 a share. Given the average P/E in your portfolio is 12x, makes perfect sense to me you wouldn’t touch it.

    Nonetheless, not every investor seeks 12x P/E stocks (even though it wouldn’t be a bad idea). Many of the people reading this site buy what they know, or what they like. You’ve seen retail interest in not only GOOG, but also SIRI and XMSR in a similar fashion. Such interest and publicity is why I bring it up on this blog.

    Okay, I’ll explain a bit further how I view GOOG, in terms of the points you raised, and hopefully someone out there will appreciate and learn from this dialogue.

    As for my use of the word “reasonable” I would say a few more things. I think the current price of GOOG (around $300) is “reasonable”, meaning it can be justified from the growth manager perspective. If I were to call it “unreasonable” I would want to infer that it was headed down dramatically because the current price could never be justified. If for example, GOOG wasn’t as profitable as it is, then it would be hard to justify such a valuation.

    So then, why would I sell a portion of GOOG at $304 if I thought it was reasonably priced and headed to $350? That’s easy. A move from 304 to 350 is only 15%. Since other stocks I follow have more upside than that, I concluded that it would be imprudent to not sell any shares. This is how I can think a valuation is reasonable, and still be taking profits.

    I fully respect your opinion that GOOG stock was a “greater fool’s game” at $170 as well. However, at that price I was paying something like 37 times the 2005 EPS estimate at the time, for a company growing north of 40% on an annualized basis.

    Often times growth stock investing requires one pay 37x earnings for high growth companies. This is not a “greater fool’s game” but rather simply the way it is. Companies growing at 20, 30, or 40 percent do not trade at 12x earnings. It would be nice if they did, but the stock market assigns P/E multiples based on growth prospects. Many great growth companies have traded and continue to trade at these kinds of P/E’s, not only GOOG and YHOO and EBAY and AMZN, but Starbucks, Whole Foods Markets, Genentech, etc.

    These companies have traded based on their great earnings growth. They are making a lot of money, unlike the tech bubble of 1999 when many of the companies weren’t booking profits, but merely page views. If these companies weren’t growing their earnings, cash flows, etc along with their sales and hype, then you would have a point about greater fools. If you think GOOG’s profits will slow and then decline, then sure the stock will suffer, but if the growth continues the current valuations will prove to have been reasonable.

    If we were at 100x or 200x earnings, like we were with the JDSU’s of the world five years ago, then I think the fool theory would be easier to agree with because the growth rates needed to justify those multiples would be impossible. In the case of 30 or 40 P/E’s though, a 25 percent growth rate for a 3-5 year period is enough to justify such prices. We can say such growth is most times difficult and unlikely, but it is possible. Clearly the GOOG bulls think it could materialize, and that is why they are paying 40x forward EPS.

    Thanks for the educated, opposite perspective of the argument. Hopefully it will be helpful for the readers, which is why this blog exists in the first place.

  9. Bill R. on August 8, 2005 at 7:34 AM said:

    “In the case of 30 or 40 P/E’s though, a 25 percent growth rate for a 3-5 year period is enough to justify such prices. We can say such growth is most times difficult and unlikely, but it is possible. “

    When was the last time a company with a market cap over $50,000,000,000 grew EPS at a 25%+ annual pace, each quarter without stumbling, over a 3-5 year period?

    Has that ever happened?

  10. Chad Brand on August 8, 2005 at 8:00 AM said:

    I would say overall sales level is more important than market cap, as market cap is simply indicative of profit margins.

    So has a company with several billion in sales ever grown 25% annually for a 3-5 year period of time? That would be the better question.

    The answer is yes. The names I mentioned before as examples, SBUX, DNA, and WFMI, have all grown between 20% and 30% annually this decade, and their stocks have been great performers. They all had revenue bases similar to GOOG in the $2-$3 billion range.

    And they don’t have to go every quarter without stumbling. The rides have been volatile along the way, but in the end, they were able to show that kind of growth record on an annual basis.

    The jury is still out on whether GOOG can match just performances.

  11. bill r. on August 8, 2005 at 8:33 AM said:

    I beg to differ. They must achieve those growth targets, consistently every quarter, to avoid taking a brutal beating on the stock price. Not only will their price drop but their valuation as well, should they miss a quarter.

    Checking the 5-year charts for those three, only WFMI avoided a 33% loss of market cap over the last 5 years, and that may be because their PS is fairly reasonable. When SBUX and DNA stumbled on their growth, it was very painful for the longs.

    SBUX in 1999, 2000, 2001, and 2002 caused considerable heartache on not matching performance to valuation. Most recently a 20-25% decline in price in 2005.

    DNA may have had that growth on a cumulative basis over this decade, but the stumbles have been horrific for the longs. They went from over $40 to under $20 from 2001 to 2003. From over $60 to under $45 in 2004. At their current PE of 90 TTM and 50 FW, they give investors a chance to ride from $88 down to the $70’s with one negative earnings surprise.

    This is part of the pattern with “growth” stocks – the high valuation prices them for perfection, that is almost never attained. It’s what makes them a trade and not an investment IMO.

    I look for GOOG to similarly get punished on the first quarter they don’t knock the cover off the ball. Fall off 10%-20% in a week.

  12. Chad Brand on August 8, 2005 at 8:53 AM said:

    Investors who have held DNA, SBUX, or WFMI for 5 years aren’t concerned with quarter-to-quarter short-term movements. Will there be bumps along the way? Sure, as not every quarter is perfect when you are managing a business for the long-term.

    You are assuming that investors in these stocks sold as soon as one quarter’s results were disappointing. Long term investors would have held on, and made up the losses and much more.

    My argument is not that there will not be a quarterly hiccup, my point was that the stocks recovered because of the growth. Stocks never go straight up without retracing the gains.

    I’m not sure what point you are arguing. My point is this. When you have a growth stock trading at 30 or 40 times earnings, one can’t automatically conclude it’s a poor investment, or as you put it, a greater fool’s game.

    If the company can compound growth at high rates for several years, say 25% annually, the stock price will be higher 3-5 year down the road. DNA, SBUX, and WFMI all support this point, short-term fluctuations are inevitable, and irrelevent to my particular point.

    Even if GOOG doesn’t blow away estimates next quarter and falls 10%, which is certianly plausible, the large institutional investors in the stock, Legg and Fido to name a couple, are not going to bail if they are invested for the long-term. In fact, Legg for one, will probably buy more, since they have a history of adding to positions on the way down more than Fido does.

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