Is Google Stock Overpriced?

by Darren

That’s a question that a lot of people have had for a very long time. And every step of the way the answer has appeared to be a resounding “Yes”. Somehow, though, the company has defied negative expectations and the stock price has remained upwards of $500 per share. Can this trend continue? Is Google’s stock overpriced?

What kind of a company is Google and where do their revenues come from?

I’ve worked with Google for years as a publisher in their Google Adsense program, and I’m relatively familiar with where they get the bulk of their revenue from. Almost all of their revenues come from the either the “Ads by Google” ads you see on partner websites, or from their own roster of web companies. Google has also invested heavily in other technology, such as YouTube, in order to build a massive revenue structure through amassing the “eyeballs” that are needed on the internet.

Google has also invested in tons of other companies, ranging from small to companies like DoubleClick. The DoubleClick takeover is jeapordy in both the US and the EU because of regulatory concerns of monopoly. All in all, Google has had a very mixed record when it comes to acquisitions, but acquiring companies based on their inflated stock prices has been one of the primary drivers of their growth. With concerns of being a monoply, acquisitions will get tougher to come by in coming years, and the chance of sustained growth in the top-line seem implausible.

Google has done a remarkable job so far. In fact, in their nearly three years, they’ve performed better than any company in history when it comes to creating shareholder wealth. But can the high stock price be sustained? More people are saying, “NO”, such as Geoff Colvin of Fortune
He used EVA to determine their potential.

Here’s what it found: To live up to the expectations embedded in its current share price, Google would have to increase its EVA, which was $2.4 billion for the past four quarters, by $2 billion annually this year, next year, and every year into the future - forever. So Google’s EVA next year would have to be $4.4 billion; in five years it would have to be $12.4 billion, and so on.

That’s what investors are counting on when they buy Google at today’s price. Are they being realistic? No, they’re not. To hit that EVA target, Google would have to invest $5.1 billion every year at its recent knockout return of 52.5 percent (assuming its capital cost doesn’t vary much). But you can’t invest $5.1 billion every year at 52.5 percent.

In every sense, the fact that Google’s growth rate seems unsustainable, coupled with higher costs of capital almost assuredly hurts potential net earnings, which will have a depressive fact on their stock price.

Google stock is definitely overpriced.