Google Offering Signals Major Moves Ahead

Leave it to Google (GOOG) to get creative a year after its IPO. Today’s announcement of a $4 billion secondary will come with rampant speculation as to how the company will use the money. It’s true that Google has been hiring like crazy and expenses will likely grow faster than sales. Their cash flow can cover those expenses without selling more shares, so the more likely use for the proceeds will be larger scale acquisitions. It will be interesting to see if and who they buy, and how Wall Street reacts to the fit of such deals. The stock is down today on the news, which is expected when any company offers stock, and the P/E on 2006 estimates is about 38 times.

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11 Thoughts on “Google Offering Signals Major Moves Ahead

  1. Bill R on August 18, 2005 at 11:17 AM said:

    GOOG had already topped out and started a decline the last time we chatted about it. Now that the institutions have “covered the evidence” by placing GOOG on their books, all the buying pressure is gone. They’ve busted the 20 and 50 day averages on the way down, and volume is also down.

    That 2006 estimate of $7.36 needs to be revised downward based on dilution of shares, doesn’t it?

    I am always amused by analyst’s focus on GOOG’s forward PE. It trades at 82 PE on a TTM basis. Of course, it traded at 93 PE last month.

    To justify an 82 with a discount rate of 11%, they need (3-stage model) 30% growth next five years, 18% for five more years, then 6% thereafter (historic S&P 500 average). We’ll see.

    It’ll be interesting to see at the end of the quarter if Legg and others added to their positions during this dip.

  2. Chad Brand on August 18, 2005 at 11:27 AM said:

    Your first paragraph is a short-term trader point of view and is independent of a long-term investor.

    The offering will dilute existing holders by about 4% if all the shares offered are new shares and not initial investors cashing out. However, if they use the cash wisely (i.e. accretive acquisitions) they can wash out the effects of the dilution, but we’ll see what they do.

    I am amused that you use TTM P/E’s. Nobody in this industy uses trailing multiples. If you look up the definition of “stock price” in any textbook, you’ll learn that “a stock price is equal to the present value of all future cash flows that will be generated by the company.”

    The key word there is future. Past earnings are irrelevent. This is why stocks react to a company’s outlook more than past results when quarterly earnings are released.

    I agree it will be interesting to see what changes are made in GOOG’s institutional ownership on a quarterly basis.

  3. Bill R. on August 18, 2005 at 2:40 PM said:

    You need to reread.
    “It trades at 82 PE on a TTM basis. Of course, it traded at 93 PE last month. To justify an 82 with a discount rate of 11%, they need (3-stage model) 30% growth next five years, 18% for five more years, then 6% thereafter (historic S&P 500 average).”

    It’s clear I apply a growth assumption to the TTM earnings. The growth assumption is also taken straight from analysts’s estimates.

    Lots of folks use TTM earnings multiples, it is the default PE ratio in most screeners. Check the links below. All of them use Trailing PE as the first or only PE ratio shown. Apparently they either aren’t in the industry, or don’t service anybody in the industry, or nobody in the industry has corrected them yet?
    http://moneycentral.msn.com/detail/stock_quote?Symbol=goog
    http://finance.yahoo.com/q?s=goog
    http://www.smartmoney.com/pricecheck/index.cfm?story=worksheet&symbol=GOOG&nav=pc_snaps
    http://www.bloomberg.com/apps/quote?ticker=goog:US
    http://quote.barchart.com/quote.asp?sym=goog&code=BMAVN
    http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=goog&sid=0&o_symb=goog

    My “amusement” is based on the stressing of “times ’06 earnings” when the default is TTM. I totally understand it! If I were in the business of defending a “buy” rating on GOOG, it sounds better to say it “trades at 38 times ’06 earnings” then to say “it trades at 82 times ’05 earnings” – it’s just easier on the ears, sounds less like 1999.

    Past earnings are just as indicative of future earnings, as are company guidance or analysts’s estimates. In other words, NONE are very predictive! But at least the past earnings actually happened …

    Some of my best buys have been immediately after revised guidance …

    Regarding the price action, I’m merely pointing out that GOOG’s runup wasn’t based on fundamentals. I pointed that out before, that the valuations are in fantasyland, but now that all the managers have bought GOOG, and the price action is gone, it’s becoming clear to the rest of the world. Don’t get me wrong, the fundies look fine, but they don’t support 82 PE – the growth assumption is unrealistic.

    Managers feel they HAVE to have GOOG. Peter Lynch explained it very well as “burying the evidence.” Managers buy winners and sell losers so they can have nice looking books for their bosses, and it doesn’t matter to them that they bought GOOG at $290, because their boss will probably fire them if they don’t have GOOG on their holdings list. Not having GOOG on their holding list would be a firing offense, and no one’s going to ask them at what price it was bought. Now that the evidence is buried, GOOG is topped.

    I’m happy for you that you sold most of your GOOG, I believe you mentioned that in your earlier thread …

  4. Chad Brand on August 18, 2005 at 2:53 PM said:

    All I said was that it is incorrect to base your valuation of a stock to anything related to trailing earnings. Stock prices reflect future earnings expectations, not past ones. Your justification for using TTM earnings as your guide is that those P/E are found in computer screening tools? Do you really think pension and hedge fund managers are using TTM earnings in screens they do? If you do, you’re misguided.

    The bottomline is stock prices are based on future earnings, not past earnings. That is why buy side analysts, sell side analysts, pension fund managers, hedge fund managers, and mutual fund managers look at forward earnings. Since we are half through Q3 already, Wall Street looks ahead to 2006 around this time every year. It always happens, and will continue to happen in the back-half of years.

    I agree that neither past nor current projections are very predictive of future results, given that there are plenty of future unknowns out there. I was just pointing out how equity valuations are calculated.

    It is also true that many managers out there “simply had to own” Google. I won’t debate that either. However, to imply that GOOG’s stock price is not tied to fundamentals is also untrue. This stock has followed profit projections fairly closely ever since it went public.

    Further evidence of that can be found in today’s price action. Upon announcing 4.3% dilution to existing shareholders, the stock dropped 5% today. If fundamentals aren’t driving the stock price, I don’t know how else to explain such a move today. Also of note was that today’s selling was done on less-than-average daily volume, hardly a sign of investors fleeing for the exits.

  5. Chad Brand on August 18, 2005 at 3:01 PM said:

    My mistake, GOOG opened this morning down 3.6% after announcing 4.3% dilution with its $4 billion secondary offering.

  6. Bill R. on August 18, 2005 at 3:02 PM said:

    Oh, here’s Fortune magazine. Note the FIRST mention of valuation is trailing earnings. Time to tell them they’re not in the business! Because NOBODY in the business uses trailing earnings …

    http://www.fortune.com/fortune/investing/articles/0,15114,1095545,00.html?promoid=yahoo

    “As of Wednesday’s closing price of $285, its shares were trading at 79 times trailing earnings—more than other Internet stars like Yahoo, which trades at 72 times earnings and eBay which is valued at 57 times earnings.”

    From the same article, they look at a valuation done by Aswath Damodaran, a finance professor at New York University and author of Investment Valuation (John Wiley & Sons, 2002).

    “In the end, Damodaran’s analysis produced a value that’s far less than the current stock price. He figures Google is currently worth just $110 per share. And this assumes that the company will grow like gangbusters, taking in $49 billion in sales by mid-2015, compared with just $3.2 billion last year—an increase of some 1,400%.

    For his part, Damodaran is baffled that anyone would pay close to $300 per share for Google. To justify paying this much, he says, you will need compounded revenue growth of about 40% a year, which would generate revenues of $135 billion and operating income of almost $30 billion in ten years. “If you believe this can happen, the stock is a good buy,” he says. “Is it possible? Sure. Is it likely? I don’t think so.”

    The bottom line: Google’s shares may not tumble today or tomorrow, but they are likely significantly overvalued. And they probably won’t stay that way forever.”

    Also, go back and check the Smartmoney link. It’s a calculator that uses DCF and future projections to produce a valuation that is also much lower than GOOG’s current one.

    I’m not implying that GOOG’s price is unsupported by the fundamentals. I’m flat out STATING it. And I’m not alone, some anonymous blogger saying it out there in the wilderness by himself, there are authors of valuation textbooks that teach finance at prestigious universities saying the same thing.

  7. Chad Brand on August 18, 2005 at 3:24 PM said:

    POP QUIZ

    Question:

    What business is Fortune Magazine in?

    a) The investment management business

    b) The publishing business

    c) The higher education business

    Answer:

    Fortune Magazine is a division of Time Warner, one of the largest media publishing companies in the world. They are a magazine. They are journalists. Are you really suggesting they’re in the business of valuing and investing in public companies?

    The same goes for professors in academia. They’re not in the business either. They don’t manage money. Do you know why? Because they aren’t qualified to do so and wouldn’t be any good at it.

    Take this quote about the NYU professor you cite:

    “He figures Google is currently worth just $110 per share.”

    Well, I’ve got news for him. To suggest with any credibility that a stock “is currently worth” any amount other than the current stock price is the silliest thing I’ve ever heard. Most people know things are worth what others are willing to pay for them. The “current value” of Google stock is $280 per share. The value of these shares in the future is what investors today are trying to formulate an opinion about.

  8. qcontra on August 18, 2005 at 8:25 PM said:

    I have a hard time valuing Google at the current price of $280. Frankly, I don’t understand how their business is sustainable over the long term when they can charge $5/click for specific keywords. Arguably, even 5 cents/targeted click may not make sense for the advertiser–I still believe a nickel/view is more than other forms of mass media.

    Sure, efficient market theorists would look at Google and say it’s worth exactly what the last quote stated. But from a value standpoint, Google will have to grow 30%+ each year for many years and maintain their high advertising margins to justify the high valuation. With greater Microsoft and Yahoo competition, I see no reason why margins shouldn’t be compressed.

    Disclosure: I’m long Microsoft. I’m not short Google, and won’t consider shorting it.

  9. Bill R on August 18, 2005 at 9:37 PM said:

    “To suggest with any credibility that a stock “is currently worth” any amount other than the current stock price is the silliest thing I’ve ever heard.”

    WOW. That’s profound. Hey, didn’t you just suggest the same thing a week ago with MSO? What about Blockbuster? They shouldn’t have to DO anything to justify their enterprise value, because in your words, it’s worth what the last guy paid for it, right? You just wrote that AMZN was too rich for you, right? Apparently that’s yet another stock that’s not GOOG that’s not worth what the last guy paid for it.

    Here’s another quote: “The key is to track stocks that might have a been a bit rich before the reports came out, and have been unfairly punished.” If a stock is worth what the last guy paid for it, then how could it have been “unfairly punished?” Didn’t the drop in price mean the punishment was de facto “fair” because “that’s what a stock is worth?”

    No, GOOG is not worth $280 a share. $280 just happens to be the last trading price for it. :-)

    Try taking 100 shares of GOOG to the Chevy dealer and buying a new Silverado with them. :p Stock certificates are not par value redeemables “worth” anything. They are a speculation that someday, someone will be willing to pay me more for them than I paid someone else for them, combined with, in some cases, a speculation that the dividend will be x and will grow, etc.

    Does the fact that Charlie Sheen paid a woman $10,000 a night make her worth that?

    Do you recall Tulipmania? Did tulips magically lose value, or did an irrational mania collapse on itself?

    “If you look up the definition of ‘stock price’ in any textbook” – hey, wait, I thought academics didn’t know diddly about this business! Why should I look in a textbook?

    I can do DCF calculations all day long. A nice heuristic I learned from reading Buffet is to take double the projected long term growth of the stock, in percent, add 9 to that, and there is the fair market TTM PE. Now, Buffet is indisputably in the business, is he not? Try it, you’ll find that it does a decent job of approximating the unlimited growth model of DCF. Oh, wait, Buffet, that’s yet another source that looks at TTM PE.

  10. Chad Brand on August 19, 2005 at 8:43 AM said:

    There is a difference between what something is currently worth (the current price) and what it will be worth in the future (the price investors care about and are trying to make an educated guess about). MSO, BBI, and AMZN are all worth what they are trading at right now, but how will that price change over time. What if MSO can’t grow as fast as many hope? what if BBI’s business deteriorates from here because the rental industry declines? How long will investors be willing to pay a PEG ratio of 3 for AMZN shares? These are the questions I’ve brought up. They will determine where these stocks trade a year or two from now.

    Yes, your Chevy dealer does not accept GOOG stock certificates, but stocks are very liquid, like other financial assets, and you can get $280 for your shares if you want to, even though they aren’t legal tender.

    The Charlie Sheen example isn’t the same thing, we’re talking about tangible financial assets, of which a date is not.

    I never said academics know nothing about the business, I said they are not excellent investors, and therefore should not be used for investment recommendations, as they don’t manage money or issue investment ideas. We can debate the future value of stocks because we don’t know their ultimate value a year from now, but what a share of stock entitles you too is not up for debate.

    There is nothing wrong with using formulas like 2x + 9 for TTM PE, but there is no magic formula for valuing stocks. If there was, it would be easy for everyone to make money. Buffett owns many stocks that trade at more or less than 2x +9 TTM EPS. I would think he would be the first to suggest he looks at it, but it doesn’t work for all or most of stocks out there.

  11. Anonymous on August 22, 2005 at 12:15 PM said:

    A stock is not worth what the last guy paid for it. It is worth what the NEXT guy WILL pay for it.

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