Tuesday, December 24, 2013

Google Inc.

Google has surpassed our former price target of about 1074 US dollars and is currently sitting at $111.84 per share.  As a result we have gone back into the model to revise some estimates. We believe that Google is a hold for the time being. The company still has so much potential and is constantly searching for feasible new revenue streams. They just launched their cloud platform, an industry that has been enjoying profits despite increasing entry, and they have many other projects and acquisitions in development. These include but are not limited to, Google Glass, their self-driving car, and of course their recent acquisition of the reputable robotics firm, Boston Dynamics. We believe that Google will see success in a lot of its new ventures as well as continued increases in their ad revenues but despite all the positive sentiment for this technology giant there are still things that can negatively affect Google’s share price in the future. The probability of success for Google’s Motorola segment is still unknown and this can potentially hurt earnings. The same story applies for any of Google’s various new business ventures that may just result in unneeded R&D costs along with other expenses that decrease their bottom line. Although confidence remains in the company to succeed and be able to introduce some new disruptive technologies to the market in the long term, Wall Street is going to continue placing very high standards on the 1000+ dollar per-share company and the possibility of them missing earnings in the shorter term is very realistic. Also all of the NSA spying allegations that we hear more about every week are sure to hurt the company’s share price. At the same time this will help keep multiples at a more realistic level and prevent an explosion in share price that isn't backed by the company’s performance and the value that Google can bring to shareholders. Google is currently trading at around 31.3x its trailing twelve months earnings. This multiple has made a hefty climb up from the 22.2x that it was trading at when the year began and is trading about 41.5% above its 5 year average P/E of 22.12x (TTM). We are hesitant to go and increase EPS estimates as many analysts have been doing but the P/E multiple used in our valuation was increased because Google along with its peers have seen much higher multiples throughout 2013. We think that this is justified in Google’s case. I have arrived at a new price target of $1,300.00 per share for the time being. We consider this a very modest estimate considering our EPS is below consensus and a P/E multiple of 26.07x was used. This increased multiple was arrived at by taking 10% less than the average between Google’s five year mean and the mean among some of its most closely comparable peers. The tablet and mobile markets are rapidly expanding as consumers are buying more and more tablets and mobile devices rather than PCs and the Android operating system is installed on over 80% of all these devices. If the company meets EPS consensus of around 44 for FY2013 next earnings call this would imply a price of 1147.08 using our P/E and if its multiple continues in the low thirties then the price per share will get above $1300 a lot sooner than we think. The emphasis on P/E is due to the fact that it represents 50% of the weight in our valuation. 15% of the valuation is dedicated to the Enterprise Value to EBITDA ratio, for which we use a multiple of 20.73x. I have not altered this multiple as it represents only a slightly higher level than the average among Google and their peers. The other multiple that holds a significant weight in our model is price to next twelve months free cash flow (P/FCF). This multiple was increased in the same exact fashion as price to earnings and makes up 25% of our valuation. We currently use a P/FCF multiple of 19.46 times the next twelve months free cash flow, which is not much higher than Google’s five year average for the multiple which is 17.16x free cash flows. Our free cash flow projections are 23.236 MM and 26.159 MM for 2014 and 2015 respectively. The remaining 10% of our valuation is represented by our DCF valuation which provided with us a price of only 961 dollars per share. This value would increase with an upward revision in earnings, but again, we are hesitant to being overly optimistic. Still, Google is one of the strongest companies in the world and although an EPS miss and overvaluation in the short term is worrisome, there is too much exciting news that comes out about this company and people seem to be on the edges of their seats waiting to see what it will do next. Our price target still represents an upside of 16.9% and a further upward revision on the price target is still on the table. The market overall has been responding very well to the interest rate increases along with the budget deal but the impacts and details of the budget deal are still under scrutiny. Equity prices across the board will most likely see some decreases because some demand is sure to shift to risk free/ low risk bond investments. Still, if interest rates increase slowly and transparently the allure of high returns in the stock markets should keep current demand intact in the short term at least.

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