Ambiguity Drives Google's Valuation

BreadMan writes "The Economist has an article about how Google uses its amorphous positioning to gain investor interest. At the current valuation (the P/E is north of 110) this is a winning formula, but the article questions the long-term soundness. The reporter was chagrined that the last press tour focused more on the CFO (Chief Food Officer) and the monthly pasta consumption (500 lbs) than products or financial performance of the company."

Comments

Proven innovation drives it...

[garcia]

IT IS hard to know whether to be impressed, suspicious or amused.

Combine such evidence of frenzied activity with mysterious secretiveness, and the imagination is liberated. A Google web browser? A Google operating system? All the world's information? World domination? Buy, clearly.

What is so hard to understand? Google, in a relatively short time, has been able to come to market with some amazing pieces of software that are stable, useful, and free even in their "Beta" stages.

I can't say that for plenty of other companies out there with huge market value... Some of those companies released "final" products that were little more than "Alpha" quality software that we tested for them on our own dimes for 15+ years.

Google, secretive or not, is producing good software at an alarming rate (yes, alarming is the word to use here) and at this time should be invested in. While I don't write for the Economist, it's pretty obvious to me that it's not Google's "ambiguity" driving its value, it's Google's proven track record which is getting people interested.

What's a couple thousand dollar gamble for most people that might have missed Yahoo's rise to fame and fortune? Knowing what Yahoo was/is doing and how that compares to what Google is doing now shows that this might be a better bet and people are willing to sink that cash into it.

Re:Proven innovation drives it...

[AKAImBatman]

Google, secretive or not, is producing good software at an alarming rate (yes, alarming is the word to use here) and at this time should be invested in. While I don't write for the Economist, it's pretty obvious to me that it's not Google's "ambiguity" driving its value, it's Google's proven track record which is getting people interested.

The rate of software development *is* alarming to investors. Investors are primarily concerned with making money. The problem with Google's business model is that the "making money" part is very hard to nail down. It's definitely there, but it's always very clear how it works on existing software. Upcoming software is even more nebulous, especially given the fact that Google doesn't necessarily know themselves.

*That* is why Google has to be ambiguous. If they don't, investors will start demanding hard (read: easy to understand) money making products. As long as Google is a black box that grows money, however, the investors are happy.

Re:Proven innovation drives it...

[nubnub]

This was insightful? What's a couple thousand dollar gamble for most people that might have missed Yahoo's rise to fame and fortune? Knowing what Yahoo was/is doing and how that compares to what Google is doing now shows that this might be a better bet and people are willing to sink that cash into it. Tell that to anyone that bought Yahoo! in 1999. Or 2000. Investing is about realizing gains, not about buying into something cool. A PE of 110, and the absolutely absurd market valuation Google has in a market with no barriers to entry is a really bad investment.

Re:Proven innovation drives it...

[Golias]

What is so hard to understand? Google, in a relatively short time, has been able to come to market with some amazing pieces of software that are stable, useful, and free even in their "Beta" stages.

That third thing is what has people so puzzled. Google's most popular offerings are "free as in beer." Yes, their search tools are so popular that they are getting embedded into operating systems and browsers, but another company could come along any day now with something better and displace them just as quickly as they displaced Yahoo. For that matter, an OS company (Microsoft or Apple) or a browser team (Mozilla, Opera) might just decide that they are better off putting out their very own superior search tools as a way to set their product apart from the competiion, and the right innovation for filtering out sites who cheat their way up the Google rankings could easilly result in stealing a lot of market share away. It's hard to lock "customers" in to a free product.

Gmail seemed like a really cool idea for about 10 minutes, until everybody suddenly remembered that we don't care about web-based e-mail.

I look at Google and ask myself, "how are they actually going to be making money in ten years?" It's hard to come up with any kind of solid answer.

I could totally see wanting to invest short-term in Google, simply because the waves of hype are probably going to keep their price going up for a while, allowing you to play the "greater fool" game for fun and profit. But long term? Meh. I like a lot of things about the company, but I wouldn't bet my Roth IRA on it.

Re:Proven innovation drives it...

[photon317]

Gmail seemed like a really cool idea for about 10 minutes, until everybody suddenly remembered that we don't care about web-based e-mail.

Perhaps you don't care, but millions of people do. There are really two "classes" of email account out there. There's personal email, and there's corporate email. In the realm of personal email, webmail is the "in" thing, and will only become moreso. That's because with webmail, it's easy to change your address, make new accounts, and to keep your email alive through ISP changes, computer replacements/upgrades, and even physical moves across the country which might entail both. It gives you a floating identity out in the ether which you can always access so long as you can find a functioning web browser. You don't have to lug your laptop to a friend's place or to the cafe, just use a random machine with a browser to get your mail.

I look at Google and ask myself, "how are they actually going to be making money in ten years?" It's hard to come up with any kind of solid answer.

I know exactly how they'll be making enormous gobs of money in ten years. They'll have most of the first-world by the throat, in total depedence on Google Magic for their day-to-day needs related to the flow of information. Search, email, blogs, photos, video, mapping, satellite data, filtering, secure remote storage, etc. Just as the first-world has become entrenched in web culture and dependent on it, they will become entrenched in Google culture and come to depend on it as well. They're taking a pragmatic peicemeal approach to the age-old plan of replacing your operating system with something in a browser - what Netscape had hoped for so long ago (and fittingly, Firefox will help Google too). Eventually whatevfer your home computing device is (PC, game console, media center, or some hybrid thereof), all that will matter is that it has a fast net connection and a browser, and while the large content may come from varying places, the small content, the metadata, and the glue that links it all together will come from Google.

You say the customer can't be locked in to these free standards-based tools, and that's true. But with the minds they have employed at Google, the infrastructure and highly-prized domain-specific knowledge they've built up, and their brand name, good luck to any company that wants to overtake them at their own game. It's Google's game to lose, and it's pretty unlikely that they'll lose it in the next decade.

CFO?

[SolusSD]

wish we had a cfo. we don even have a vending machine!

Lets be honest

[davidmcw]

500lbs is an awful lot of pasta

Re:Lets be honest

[14erCleaner]

500lbs is an awful lot of pasta

If you read the article, you'd know that they use 3 pounds of coffee beans for every pound of pasta. No wonder they're so productive, they never sleep!

Google is people not products

[cyngus]

Perhaps reporters are looking at things the wrong way. The reason for Google's success and break neck product generation pace is the people that work for them. Maybe you should be more interested in their habits if you want to know where Google is going. More to the topic of valuation though, Google is highly valued because their growth is tremendous, their has been almost no growth deceleration, and they generate huge amounts of cash. I believe they are on course to generation $1.8B in cash this year, something very, very few companies can say. Is it worth what the stock is trading for? Clearly, no one knows, but many think it is. Google's growth will start to level at some point, but the thing is that when you're growing this fast, slowing growth down only a little later (or earlier) is going to make a big difference in absolute sales or profit numbers. So, timing of the leveling off is crucial, but almost impossible to predict.

Re:P/E

[Momoru]

Ok for their P/E to be 1.0 their stock price would have to NEVER change from where it is now, and they would have to start making Microsoft dollars

The current FORWARD P/E on Google is still 45. Personally I think earnings will be lower this quarter because of so many aquisitions, and multimillion dollar $0 options the senior execs have taken.

Overvalued Stock --

[Anonymous Coward]

Let me offer a bit of instruction to fellow geeks.

One way to value a stock is to compute its future earnings, discount them and figure out its value today.

So for example, if Company X pays out $10/year, every year, how much would you pay to buy Company X today? To compute this, you do the following calculation: $10 + $10/(1+intrate) + $10/(1+intrate)^2 + $10/(1+intrate)^3 + ...

Intrate is the prevailing interest rate. Clearly, the company has to cough up $10 for the first year. For the second year, (if int rates are 5%), the company only has to cough up $9.52.

In this example, the value of Company X is about $210 today.

Clearly, a succesful company will be able to pay out ever growing dividends. The confidence in growth is computed down to the P/E number, price/earnings.

In GOOG's case, the P/E number is now 120!. This is an absurd number.

Comparable tech companies sport the following P/Es:

Ebay: 58
Yhoo: 58
Msft: 25
Goog: 120 (wtf?)

GOOG is probably overvalued. By a lot.

Re:Overvalued Stock --

[drtomaso]

Theres also another way to look at this. P/E is defined as "a stock's market capitalization divided by its after-tax earnings over a 12-month period, usually the trailing period but occasionally the current or forward period." (investorwords.com)

Thus, we can think of it as such- how many years would it take Google to buy back all of their outstanding shares at the current market price assuming their earnings stay fixed? Right now the answer to that question is 120 years. Do you honestly believe GOOG will exist in 120 years?

Of course, this argument assumes their growth stops and doesnt decline. YMMV. Thats why the parent poster's comparisons to similar tech companies is so poignant. During the "pop" of the internet bubble, companies with P/E of over 70 suddenly lost as much as 97% of their value (assuming they survived at all). GOOG is closer to double that.

Innovation, nor expertise is driving GOOG up. It's 100% pure unadulterated hype. A P/E of 120 indicates a massive market inefficiency. Unfortunately for the good people of Google and its investors, the market has a nasty way of correcting itself, eventually but never-the-less inevitably. The real losers of the Dot-com days were the investors who fooled themselves into believing that rule didn't apply to them.

Re:Proven innovation?

[GeffDE]

I have no idea whether that is supposed to be a joke, or if you are actually living back in 1998. I suppose that an automated advertising service whose gross margins are as close to 100% as you can physically get is not at all profitable. Or that Google's profits are larger than Time-Warners means that nothing that they make is profitable. On the contrary: Google uses its simple, old technology as a massive cash-cow, that coupled with its killing in selling stock, is funding the development of "un-profitable" innovations. Except that those innovations are profitable. How can they be profitable if they are free as in beer? Because in Google's revenue model, the end user is NOT the customer. The sheer mass of end users is what makes Google so attractive to the customer: companies who need to advertise. Google's innovations expose end users to Google's customers more and more because end users use Google's nifty, useful innovations.

Re:The CFO is more important than quarterly number

[passthecrackpipe]

I think the article is spot on, and the reporter is not confused about anything at all - the reporter is rightly asking what the valuation of the stock is really based on - reporter notes vague handwaving, a non-committal (beta) software stream, much, much rumours, and the fact that people at google like to eat. The reporter asks - in not so many words - how and when google will start delivering on that stock price - i.e. where google's *80 billion* valuation is hidden, and how, if at any time at all, this will be capitalised.

Google's success is not at doubt, rather, the reporter draws some subtle parallels to the dotcombusts of yesteryear, and hints at potential repetition and subsequent dissapointment of those times.