The Proficient Investor

One of my readers emailed me the other day asking if I still thought Google could reach $950 since it has fallen so hard over the past few months and I thought I would share with you my answer.

Here it is:

Hi.

I still think in the long run Google is going to hit $950 and here’s why. Google doesn’t like to split the price of their stock so you have to look at it like a $42 stock right now.  For growth stocks like this, I look at their earnings. Here’s the formula that works for stocks like this with high multiples (or high Earnings Per Share…EPS).

I use Etrade but you can use thestreet.com or yahoo finance just as easy. Go to the earnings estimates and what you are looking for are next years and this years earnings estimates.

Next year’s earnings estimates are around $25 and this year’s around $20…

So, I take next year’s earnings and subtract this year’s earnings $24.91 - $19.98 = $4.93 then divide that by this year’s earnings $4.93 / $19.98 = .2468 then multiply that result by 100 to get the percentage of growth .2468 * 100 = 24.68

So Google is looking at 25% growth roughly over the next year. Consider that institutional investors (hedgefunds and companies like bear stearns or goldman sachs will pay twice the growth in terms of PE (price to earnings ratio)). So a big firm like Goldman is willing to pay 50 PE for the stock. So we look at their current PE.

Google’s current PE is 33 so that means Google, right now is very cheap and undervalued according to these projections. Now if you want to be conservative you can multiply the growth by only 1.5 times and you get a 37 PE.

So let’s be conservative and multiply that 37 times the current earnings per share and we should get a figure that tells us where to sell the stock because at that price it’s fairly valued. 37 * 13.28 puts the stock at $492.

This is the kind of homework I do for any growth stock be it Coca Cola (KO), Goldman Sachs (GS), Wells Fargo Bank (WFC), you name it. If it’s considered a growth stock or some call it a value stock…you can do these kinds of calculations. Now this only works for projecting 1 year out…multi year projections become much more complex and I don’t really bother with them because I only look for growth 18 months out. By the way, if you didn’t calculate the 2X figure…you get a stock price of $664. That’s a nice gain from here. Google can do that easily over the next 18 months. I don’t see it going much lower from here considering the beating wall street has already given it. Even still, now is a good entry point because it’s bouncing off the 52 week low and the 10 day moving average volume looks pretty good. I’d say if you want to buy it here, buy a quarter position or maybe half. If you want to own 100 shares for example you would buy 25 or 50 and hope it drops a little so you can buy another quarter or half…then as the stock gains momentum and the price increases, you peel off those positions when they are profitable taking either half or your original quarter position to your target price. That’s how you make money and stay in the game.  We call it playing with the house’s money.

 Anyway, I know that seemed like a long explanation but I hope it helps you understand how I look at these kinds of stock.