Why Google is a $1,900 Stock

Everyone uses Google to search the web. More than 90% of all internet searches are taken place over Google and its subsidiaries and there are 3.5 billion searches via Google per day. (Business Insider, 2018)As a result of Google’s frequent use by the consumer, the word “google” was added to the Oxford English Dictionary in June, 2006. It is this brand name that is world renown and as such should provide a compelling argument for a higher valuation.

Google’s Market Share of Internet Advertising

Digital ads are everywhere on the internet. It would be hard to browse the internet without coming across an ad or a pop-up window. As a result, companies are paying billions of dollars for this marketing and that number is expected to grow in the near future.According to a March, 2018 eMarketer study, Google’s 2018 market share of digital ad spending is forecasted to be 37.2% while the next biggest competitor is Facebook with a 19.6% estimated market share. Google’s market share in the digital ad market has slightly decreased since 2016 when it was 41.1%. However, total digital ad spending in 2018 is forecasted to grow 19% year over year to $107 billion. New competitors are entering the market and taking market share from Google (Amazon for example); however, Google’s revenue from digital ads will increase by a far greater amount than by the small amount that was lost due to a change in market share.

Ownership of Youtube

In November 2006, Google purchased Youtube for $1.6 billion. That acquisition has turned out to be a great purchase since Youtube is now one of the main places teens and adults turn to for social media. In a March, 2018 survey released by the Pew Research Center, it was discovered that the number of Americans using their computers or phones to access Youtube was 73% while Facebook was second at 68%. Similarly, in this same study, the percentage of teens ages 18-24 using Youtube was an outstanding 94% while Facebook trailed behind at 80%. (Social Media Use in 2018, 2018) These results indicate that Facebook is not the only dominant force in social media. In fact, Facebook has lost its market share leadership as seen in the categories mentioned above and in the Pew Research image below.  

As seen above, Youtube is heavily favored in the U.S. by adults ages 18 to 49. If Youtube can successfully retain this demographic (U.S. adults ages 18 to 49) as a loyal customer base while continuing to appeal to the younger age range, the company should be in great shape to be one of the dominant social media leaders, quite possibly surpassing Facebook. 

New Products and Innovation

Over the last four quarters (from Q217 to Q118), Google has spent roughly $18 billion on research and development. To place that figure in perspective, Google’s research and development expense was about $1.4 billion from Q206 to Q107, nearly a thirteen times increase from 2006 to 2018. It is this spending on new products and innovation that has kept Google at the forefront of technology. Some of their most recent leading-edge developments include Google AI (Artificial Intelligence), Google Assistant, Google’s Tensor Processing Unit 3.0 (machine learning), virtual call center agents, and a Google AI news feed. This great investment in research and innovation gives a reason for many investors to continue to believe Google has great growth potential in the years ahead.  

Google’s Valuation

Google’s earnings per share (EPS) over the last four quarters was $23.62 (as of Q218). Applying a 15% growth rate to that earnings per share over a 5 year period results in a projected EPS of $47.50 in 2023. If we discount the EPS of $47.50 at a 5% discount rate over five years, we get a present value EPS of $37.22. Multiplying that present value EPS of $37.22 by Google’s current Price to Earnings ratio of 51.04 (as of 7/23/18) results in a price of $1,900.  

The two main assumptions here are the 15% growth rate in earnings and the 5% discount rate. Given the points mentioned above (online ad market share dominance, Youtube’s demographic success, and Google’s R&D spending), it is reasonable to assume a 15% growth rate over the next five years can be achieved. We also believe that a 5% discount rate should be used in valuing Google because of Google’s dominance over the internet, specifically from its search engine and its continued innovation from its great spending on R&D. Therefore, these future cash flows should not be discounted at a higher rate because they are not as risky as other investors may believe.  

Google has had a great Q218 earnings release and the price of Google stands at around $1,250 per share. It would not be far fetched to see Google at $1,900 given the aforementioned reasons discussed in this article.