Analysts Got It Right As Google Passes Wal-Mart in Market Value

Regular readers of this blog know that sell-side analyst research reports are not something I reference very often for trading recommendations. The numbers show that analyst picks fail to beat the market consistently, and do so with more volatility, just as most mutual funds do. That said, given that most Wall Street research is positive in nature (they want you to buy stocks, after all, so they make money) there will be a lot of times that I agree with the analysts, merely due to probability.

In May I wrote positively about search giant Google (GOOG) when it was trading in the low 460’s (Google Looks Cheap, Believe It Or Not). At the time I wrote that upside to $600 per share looked like a conservative price objective, with downside limited most likely to only $450 per share. This view was also the consensus view on Wall Street, with most analyst price targets right around $600 per share.

Well, the analysts got it right this time, so let’s give them credit. Google crossed $600 per share this week, jumping $5 yesterday to reach an all-time high of $615 per share. In doing so, Google now has a larger market value ($192 billion) than Wal-Mart (WMT) ($184 billion), a fact that many seem to find pretty staggering. I want to make two points about this in justifying why investors should not be alarmed by recent trading action in Google stock.

First, the reason why we see analysts now raising their price targets on Google closer to $700 per share is due to the fact that 2008 earnings estimates are approaching $20.00 per share (As I predicted in May) and the company’s growth rate should be in the 30 percent range for the next several years. Most any investor will tell you that a P/E equal to or slightly above a company’s growth rate is fairly common.

A conservative valuation on Google of 30 times earnings gets you to $600 per share, and a P/E of 35 or 40 for one of the world’s fastest growing companies is a price tag that many investors will be willing to pay, hence the rising price objectives. Personally, I would not be loading up the boat on Google at current prices, but a trading range of $500 to $700 per share over the next six months or so seems reasonable. Given we are right in the middle of that range right now, Google shares are a solid hold, with a bias toward profit taking over purchasing if a trade needs to be made.

As far as the Wal-Mart market value comparison goes, the discrepancy that might seem overdone to the casual observer really isn’t out of whack with reality. In 2008, Google is expected to earn a profit of $6.1 billion, which is less than half of Wal-Mart’s expected net of $13.8 billion. This implies a P/E on Google of more than double Wal-Mart, which is the case (31x vs 13x forward earnings). However, given that Google’s margins and growth rates are far higher than the world’s leading retailer, investors can easily justify the market values of both companies. That said, Wal-Mart appears to be the better value, trading at a below-market multiples, versus 2x the market for Google.

Full Disclosure: Long shares of Google at the time of writing

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10 Thoughts on “Analysts Got It Right As Google Passes Wal-Mart in Market Value

  1. Al Rob on October 10, 2007 at 9:57 AM said:

    Maybe GOOG is fairly valued here but what is the upside? Where do you go from here?

  2. Chad Brand on October 10, 2007 at 10:13 AM said:

    Well, that depends on your view of the company’s EPS growth rate going forward and how the P/E will reflect that. Right now the consensus is for 25% annual EPS growth for the next 3 years (2008-2010). Assign a PEG ratio in 1.2 to 1.5 range and you get price objectives between $600 and $750 on ~$20 in 2008 EPS.

    Unless you think either 1) the P/E will not be above their growth rate, or 2) GOOG can’t grow 25% annually for the next 3 years, it’s a good bet that the stock will outperform the market over that time.

  3. If I were to base my px tgt on forward earnings I’d give them a 35 multiple on S&P’s 2008 Core EPS estimate of $15.66. Gets me to about 550.00.

    I participated in the IPO and sold around 350.

    GOOG’s growth has been amazing but i can’t get too excited now given pressure on margins, slowing Top Line growth, and rapidly increasing capital expenditures. It’s cliche but I would like to see them demonstrate some traction in another area of their biz. I guess I just view the shares as being priced for perfection so I’d pass on GOOG here.

  4. Chad Brand on October 10, 2007 at 11:33 AM said:

    A perfectly reasonable stance, and you are certainly not alone there.

    I think including options expense is irrelevant though, as it is an accounting measure, not an actual cash expense. Options issued impact earnings per share already by increasing the total share count, thereby reducing earnings per share.

  5. True, Options are fully reflected in the diluted EPS but in practice most companies spend huge sums of cash repurchasing stock to keep dilluted EPS flat. The options themselves are a non-cash expense but the companies efforts tp keep them from hurting results are a significant use of cash that could be distributed to existing shareholders or used to grow the company.

  6. Chad Brand on October 10, 2007 at 12:02 PM said:

    Absolutely, but I would think how companies spend their money would factor into the multiple investors are willing to pay for a stock (less productive uses of cash lead to less growth, which leads to lower P/E ratios), rather than the earnings per share calculation, which already reflects the dilution from options issuances.

  7. Al Rob on October 10, 2007 at 8:44 PM said:

    I don’t think that many GOOG investors are very picky about stock options expensing policies. That’s cool, there are many different ways to be a successful investor. My method says GOOG is a too expensive here for me.

    Anyhow back to the main topic. Isn’t your price target the price you will sell at or is it more of a loose goal? If not, what is the point of the target? GOOG has hit your initial target of 600. You say GOOG is a “solid hold, with a bias toward profit taking”. Why not just sell and move on to another idea with more than 20% upside to a price target?

    Finally, I am putting a $12,000.00 price target on GOOG which is 30x my 2015 EPS estimate of $400.00:-)

  8. Chad Brand on October 11, 2007 at 5:40 AM said:

    I think a forward P/E range of 30 to 35 is reasonable. We are on the low end of that now, so I would not be a buyer here. As we get into the upper end of that range, I’ll be looking to unload some stock.

  9. Bobby Kolev on October 11, 2007 at 2:55 PM said:

    Nice to hear you are not considering entering GOOG at this moment.

    I did lose lots of money since you last recommended them, but I am just afraid of their business and there are two simple reasons for that (agreed, none of them solid enough to be classified as an argument against sound quarterly report numbers):

    first, google’s advertising business is long not as appealing to me as a business as it used to be; you pay too damn much for what you get back. I think they’re still riding on the initial success of their concept, but I also think most of the companies giving them money have not yet learned to measure the ROI that Google advertising is bringing them and are practically pourig money into Google.
    That will certainly change.

    2) Google has raisen up so much on a single product it simply MUST fall, and, like many similar sharp successes (apple, palm, vonage) it’ll likely be a sharp drop too.

    Granted, they still have the best Internet search engine I know of and as such will continue being profitable for quite some time.

    And yet, at this price point, I’d rather pass.

  10. Chad Brand on October 11, 2007 at 3:22 PM said:

    In my view, the key metric for Google is online advertising as a percentage of the overall advertising market, since they still have yet to diversify into other areas.

    As long as online ads continue to take a bigger share of the overall ad pie (which they should given the traffic growth of the Internet), and Google remains the online advertising leader, the company should be able to continue to grow. Once that trend stops, they will need other engines for growth.

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