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$500. $600. $2,000. Do I Hear $10,000? $0?

Yes, the Google price target brouhaha is reminiscent of the 90s–and not just with respect to dotcom stocks.  The Dow, too, was the subject of a few heroic hypotheses in those days (Dow 36,000, Dow 100,000), utterances that, in hindsight, came to be viewed as preposterous, asinine, and irresponsible.

Unfortunately, then as now, many observers are drawing the wrong lessons from these exercises.  The important lessons are not that analysts and investors are “cheerleaders” or “overexuberant,” or often look boneheaded in hindsight. (Of course, they often look boneheaded in hindsight.  They’re forecasters.)  The real lessons are these:

  • First, valuing stocks is a highly subjective exercise: There is a vast difference of opinion about the “fair value” of even broad indices like the S&P 500 (some respected analysts think it’s cheap; others–even more respected–think it’s at least 30% overvalued).  With stocks like Google, this uncertainty is so magnified that you could fly a 747 through a range of reasonable price targets.
  • Second, no one knows for sure what stocks are worth.  No one.  If you don’t believe this, get a spreadsheet, project a hundred years’ worth of cash flows for Google, and discount them to the present.  Don’t forget that Google could end up like Microsoft or like DEC (very different cash flows) and that an appropriate discount rate–one that compensates you for the risk to the cash flows–could range between, say, 7% and 20%.  When you think you’re done, change your assumptions a bit and see what happens to the “fair value.”  Change them again. Eventually, you’ll probably conclude that the stock is worth somewhere between $25 (cash per share) and $1,000.  Now pick your price target.
  • Third, a diversity of opinions about what stocks are worth (assuming the conclusions have well-reasoned arguments underlying them) is more helpful to someone trying to form his or her own opinion than simple regurgitations of the comforting consensus of the herd.  Why?  Because the consensus, unfortunately, is usually wrong.  (When Google went public, the consensus was that it was overvalued at $85.  Boy, does that seem ridiculous).  I don’t find the analysis underlying Mark Stahlman’s Google-could-go-to-$2000 particularly persuasive, but I appreciate his reminding me not to automatically make the same mistake with the stock that almost everyone has since the IPO: underestimating it.
  • Fourth, valuation is only one of many factors that drives stock prices in the short and intermediate-term (the timeframe that unfortunately obsesses the press, Wall Street, and most investors).  Also, alas, valuation is practically worthless as a tool to try to figure out what stocks are going to do next.
  • Fifth, there is no difference between raising a target from $450 to $600 and raising it $45 to $60, so don’t get distracted by the extra zero.  Warren Buffett is viewed as the pinnacle of reasonableness (deservedly), and his stock is trading at $89,000.  Imagine the ridicule that must have rained down on the poor fool who predicted back in the 1960s that this might be possible.
  • Sixth, analysts have to put ratings and price targets on stocks–that’s their job.  You don’t.  You can just say, “I don’t know, and I don’t care.”  (And when your buddy’s ribbing you about how much money he’s making in Google, you can also, perhaps, console yourself by saying, “And he doesn’t know, either.”)
  • Seventh, yesterday’s INSANE price objective might seem quite reasonable tomorrow.  An analyst who slapped a $500 target on Google 18 months ago at the IPO would have been branded a crackpot.  Same for an analyst who in 1982 said that the Dow would rise from 1,000 to 10,000 (or, in 2000, drop from 11,000 to 7,700).  So let’s not rush to dismiss as lunatics those who are calling for Dow 2,000 (down 80%), Dow 20,000 (up 80ish%), or Google $600.
  • Eighth, relative valuation–assessing the value of a stock by comparing its multiple to that of other stocks–can, unfortunately, be a fool’s game (It doesn’t much matter whether a stock is cheap or expensive relative to another stock if the market crashes).  Unfortunately, investors and analysts with time horizons shorter than 5 to 10 years usually don’t have the luxury of focusing on absolute value.
  • Ninth, even now, the most amazing thing about Google is not the stock price but the cash flow.  Say what you will about the silly name and zooming stock, but a seven-year-old company is already generating nearly half as much cash as the biggest media conglomerate in the world.  That’s amazing.
  • And, so, tenth, most price targets aren’t worth anything like the hullabaloo that is often paid to them.  They should be seen as arguments and hypotheses, not pinpoint predictions, and the best ones–the ones supported by well-reasoned logic and an impartial analysis of the facts–can be helpful for developing and refining your own conclusions.

So, now that we have collectively explored the upside case for Google, instead of another article about how Wall Street analysts are obviously going nuts again–or another analyst report about how Google might go straight to the moon–I’d like to read a well-written piece arguing that Google might go to zero.  Not only because that’s the only Google argument that I haven’t heard in a while but because it’s the only new Google call left.

Disclosure/Reminder: I don’t own Google (unfortunately), I think it’s overvaluedI think it could go to $600 or more or $300 or below, and please don’t construe anything I say on this blog as an investment recommendation or advice (because it isn’t).

8 thoughts on “$500. $600. $2,000. Do I Hear $10,000? $0?”

  1. Having read about the famous Blogett I was expecting to find a blog full of wild and amazing speculations. This is one of the most well written, simple, pointed explanations of the stock valuation game. People who write about valuations (the press) often profess astonishment at valuations. Like you say, anyone who has actually played with dicounted cash flow valuations (the way people model future value of a stock) know that they’re extremely sensitive to changes in your assumptions about a company’s growth. Assume google will grow only 20% for the next 5 years. It’s only worth $200 or less. Assume google can grow 35% or 40% per year for the next five years, then it’s worth $700 or more. The point is, we don’t *know* what it’s growth will be. Every quarter we get another datapoint, but that doesn’t make speculation much easier. The only thing I think is sensible, is to look at the macro factors – search is in a huge secular growth phase, china is a huge potential new market, and google has a great set of engineers. Those things tell me that i should have a *position* in google, but it doesn’t tell me, like you point out, whether i should buy at $400 and jump out at $683. People who think like that always end up with no money, because they’re *gamblers*.
    Thanks for the great post!

  2. I concur with the above comment. Like most of your stuff, Henry, this is thoughtful and very well written. Parking everything you’ve gone through, it is great that you are back sharing your thoughts again, and so insightfully to boot.

    Now, how about *you* writing the “GOOG to zero” piece? 🙂

    – Stuart

  3. Nice.

    One issue is, going back decades, the ‘media’, in their effort for readers and, thus, ad revenue, is eager to ‘grab’ at people by the heart, the gut, lower still. In particular, they like to present their ‘stories’ as spectacular, exceptional, and, thus, worthy of attention.

    For actual thinking, evidence, reasoning, support for conclusions, primary references, even descriptive statistics as summary descriptions of situations, even just for the usual high school term paper writing lessons, the media regards such content as boooooooooring and snips it out.

    So, to get a better ‘story’, the media likes to ‘cherry pick’ the data. In any serious writing, e.g., medical research, get caught ‘cherry picking’ the data and can end up in a very different career.

    With wildly strong contrast, in serious fields, e.g., research in mathematics, physical science, engineering, the conclusion is secondary and the real interest is in the supporting evidence. Or, for an interesting theorem, want to see a rock solid proof (in the style of N. Bourbaki) right away. Without the evidence, the conclusion isn’t even useful to join the newspaper kitty litter. The media, of course, cares only about what can be made to look like spectacular conclusions and never wants to consider the evidence.

    Or, as the media distributes their ‘content’ over the Internet instead of on paper, think of the resulting boom in sales of clay-based kitty litter!

    The ‘dynamics’ of bubble blowing go way back, at least to the tulips, and are fairly well understood. In this effort with industrial hot air generators and railroad tank car loads of soapy WonderBubble, the media has been an eager colleague.

    A more complete look at the data should be at least illuminating, possibly useful. Of course, to the extent that more illumination is harmful to the bubbles, the media will not be interested on the ‘upside’. But, part of what the media likes is also the ‘downside’ — first build it up; later tear it down; get two, count them, two stories in one! So, in time the media may be interested in applying their cherry picking to downside ‘stories’.

    Yes, much of the work in the ‘rational’ evaluation of stocks is of the form: There is a whole lot of data that we don’t have and essentially never really can have but which if we did have would let us do an involved calculation and come up with an expected value for the stock. And if pigs had wings, then we could make money selling really strong umbrellas. Sure: If make enough assumptions about enough aspects of the situation being ‘stationary’, etc., then at times can argue that if collect data long enough can make estimates that converge and have useful accuracy. While such things can work in some problems, tough to do with stock prices. With the meager data we do have, can find that to cover nearly all the probability mass, have to have a range as wide as $25 to $1000 like you did.

    For something that could be done and might be useful:

    o Range. Have (to avoid cherry picking, in advance) a collection of stock analysts. Collect the analyzes of all of them and compare over time with the other analyzes and also, later, with reality. Then, in this context, for a particular stock, say, Google, report what ALL the analyzes in the collection say, hopefully over time. So, get the ‘range’ of analyzes. Maybe this would be called a ‘consensus’ approach.

    o Business Model. For a company such as Google, look at the business model, what it’s been, what it is, what it’s been yielding in revenue, and what it might be. I.e., at least have some ‘scenarios’ with some contact with reality. Maybe this would be called a ‘fundamental’ approach.

    o Empirical. Take revenue, earnings, and growth rates in these along with stock prices, build an empirical statistical model, and use the model to estimate Google’s stock price and, of course, also the confidence interval of the estimate. Of course, that interval might be your $25 to $1000. If so, then that, too, would be interesting. Maybe this would be called a ‘quantitative’ approach.

    And, easy enough to identify other approaches.

    Should the media really want to have some possibly useful information on the price of Google, such content would be crucial.

    That we can’t know anything at all even reasonably solid about the price of Google strikes me as giving up too soon.

  4. Imagine this – all future web sites encrypted their web pages, and customers who entered a simple key (stored on their PC) could access the web page. Search would dry up overnight. I don’t this scenario will happen, but then DEC laughed at the PC and see where we are now.

    Google hasn’t faced any serious challenges yet. You have to remember they are an advertising company based on Search. You’ll see them getting serious when their search improves and they stop doing all the other distracting stuff whic doesn’t generate any revenue whatsoever.

    Finally remember Microsoft -it’s grown a new $4 billion dollar business every year for the last 4 years. The law of large numbers will eventually catch up to Google as well.

  5. When Enron launched Enron Broadband, their stock shot through the roof. The assumption (at the time) was ‘whatever Enron goes into, they’ll make money at it.’ Google has launched a bunch of products that have yet to generate significant revenue (video, earth, base, pack, news, local, orkut, answers, etc) and many of these launches have resulted in stock jumps on the assumption that Google will someday make money off these. Granted, these are actual products – unlike Enron – but the blind euphoria is the same.

  6. Most analysts are really salespeople. So I wouldn’t listen to an “advice” from them.

    Make your mind up for your self. And if your intelligent and have patience stay away from companies that you can’t valuate or whoose stock prices can’t be justified against the valuation, like for example Google.

    Buffet and Graham would never buy Google because they could never valuate it with confidence or understand what it’s doing.

  7. GOOGLE is a good company and so is its stock. The problem here is the unreasonable bubble developed in the P/E ratio. At a PE ratio of 40, or price of $314 per share, a lot of disaster in the stock market can be saved by avoiding the bubble burst.

    Look at the real estate world. We still don’t learn from the bitter experiences?

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