Operational and Financial Outlook of Google - Essay Example

?Contents 2 Introduction 3 1 History of Google 3 2Financial Valuation 3 2 Introduction to equity valuation 3 2.2 Equity valuation techniques 3 2.3 Net Asset Valuation 4 2.4Price/Earnings Valuation 4 2.5Dividend Growth Model 5 2.6 Different form of markets 6 3 Cost and benefits of going public and issuing shares 7 3.1 Advantages and disadvantages of issuing equity shares 7 References 8 Abstract Google can be regarded as the leader in the technology industry in the current era. The company has been expanding by leaps and bounds during the past decade and its operational and financial outlook looks amazing. In August 2004, the company made its Initial Public offering (IPO) and officially got listed on the NASDAQ index. The paper presents an analysis regarding whether the shares issued were at premium or below the rightful price. This analysis has been conducted based on several financial theories related to equity valuation. 1 Introduction 1.1 History of Google Google, a name synonymous with world leader in specializing in internet related services and product. The product and services offered by Google are vast and its operations are expanding at a rapid pace. The primary services offered by this giant corporation include cloud computing, software and online advertising. As per the latest and historical financial analysis, the company has been deriving its main revenue from the Adwords. Google was founded Larry Page and Sergey Brin who own about 16% of the shares of the company as per the latest annual report of the company. Soon after the initial public offer (IPO), the company’s revenue, and in turn its profitability has increased by leaps and bounds. The initial public offering of the company took place on August 19, 2004. On this historical date, around 19,605,052 shares of the company were offered at a price of $85 per shares. The mode of the sale of the shares was suggested to be through online auction. Through this IPO, the company was able to generate a great deal of capital amount to around $ 1.67 billion resulting in a market capitalization of over $ 23 billion. However, the majority of the Google shares remained under the control of the Google. The paper evaluates the price of the shares of Google at the time of its IPO. Through applying different equity valuation method, it can be evaluated whether the share was overpriced or under priced. 2Financial Valuation 2.1 Introduction to equity valuation Equity valuation can be defined as the process of identifying the current market value of the company which is also regarded as the current market capitalization of the company. There are several step of equity valuation process and it requires an adequate understanding of financial management techniques and acumen. 2.2 Equity valuation techniques The most important step in equity valuation process is the selection of an appropriate valuation model. Few models widely used in financial evaluation are as under: Net Asset Valuation Price Earning Valuation Dividend growth model Based on the above valuation models, an analyst predicts the equity value of the company by selecting any one of the above mentioned models which appears to be apt in the circumstances. Finally the investor must make an investment decision based on the calculated value of equity in the above step. This decision involves investment recommendation to the investor whether it is financially feasible to invest in the stock of the company being valued or not. If the analyst concludes that the equity value of the company is as such which is significantly greater than the current book value of the company, then it represents that the company will reap benefits in the future for the investors, thus the investment decision would be financially viable. 2.3 Net Asset Valuation Net asset valuation is also called the net worth of a company. It is simple valuation model which is based on the recoded balance on the balance sheet items of a company. The stock price of the share under this model can be calculated by divided the net worth of the company to the number of share (Neale, 2003). The table below indicates that the value of the share value of the Google at the time of the IPO. Years 2003 (in$) 2004 ((in$) Net Assets 588,770,000 2,929,056,000 Number of Shares 137,697,000 193,176,000 Per Share Value 4 15 2.4Price/Earnings Valuation Price earning valuation is well known measure the value of a company. It is one of the commonest methods of valuation in practice which is entirely based on accounting profit. As P/E ratio is simply the market price of a share divided by the last reported earnings per share (EPS) P/E ratios are cited daily in the financial press and vary with market prices. A P/E ratio measures the price that the market attaches to each ? of company earnings and thus superficially is a sort of payback period (Lnch,1989). Years Particulars 2002 2003 2004 Earnings Per Share (EPS) 0.86 0.77 2.07 Market Price Per share (MPS) N/A N/A 100 P/E Valuation     48.309 Average P/E Valuation 48.31 Avg Earnings Per Share at 2012 1.23 Share Price 59.58 2.5Dividend Growth Model Shareholders attach value to shares because they expect to receive a stream of dividends and hope to make an eventual capital gain (Gordon,1960).The model is a method for valuing firms using dividends and their growth discounted to today’s value. It assumes that the company issues a dividend that has a current value of D that grows at a constant rate g. The model assumes that 1- The amount of a company's dividend for the next year, [D.sub.1], can be accurately estimated, 2- The dividend is payable at the end of the year, 3- The dividend will grow in perpetuity at a constant rate, g, and 4- g is less than the required rate of return on the common stock, k. Using the model, the price of the stock (i.e., the present value of the increasing annuity), is calculated as shown in the following equation: For the purpose of calculating the cost of capital, Capital Asset Pricing Model (CAPM) has been used. The model is based on the following formula: The CAPM formula for calculating the cost of equity is as follows Where ‘Ke’ is the cost of equity, ‘Rf’ is the risk free rate, ‘Rm’ is the market rate of return and B is the beta of the company. Risk Free Rate [average rate on 10Y UK bonds issued by the Government] 7.50% Average Market Rate [FTSE 100 index] 8.59% Beta 1.03 As per the CAPM formula, the cost of equity is 8.62% But as per the annual report of Google for the financial year 2004, the company did not paid any dividend nor it was the policy of the company to pay any dividend in the near future. So as per the dividend growth model, the value of the share price of the Google at the time of its IPO was nil. This shows that the issuing price of the shares of Google was higher (i.e. of $85) than the ones calculated under any of the above method. This might be due to the fact that the company appeared to be lucrative for many of the stakeholders, including the investors. Any company which promises better future performance and financial outlook, the share price usually rises and the investors can reap benefits through capital gain. 2.6 Different form of markets One of the reasons behind the Google’s initial price being higher than what various financial theories have suggested is due to the fact that American stock market is strong form efficient. There are three types of stock markets namely: Strong form efficient Semi-strong form efficient Weak form efficient In a strong form efficient market, the information pertaining to the company’s future plans and future financial outlook is readily available in the market due to which speculation can take place and share price fluctuates a lot. In these types of market, the shares are usually traded at higher prices than their actual values. In Semi-strong market information is not available that much readily and there is some speculation. Whereas, in the weak form efficient, there is no speculation and the share price is being traded based on historical pattern. 3 Cost and benefits of going public and issuing shares In order to finance any project, a company needs to raise capital in the form of revenue funds, short term finance, long term finance, running finance etc. Raising capital can be a significant and crucial task for any company as several technicalities and procedures are involved. It is generally observed in an economic scenario that the company with a good credit history and uplifted financial outlook is likely to raise funds easily as compared to the otherwise. Raising capital significantly affect the gearing of a company. 3.1 Advantages and disadvantages of issuing equity shares Both modes of financing i.e. equity and debt, comes with their advantages and disadvantages. Several factors, such as statutory rules and requirements, terms and conditions imposed by the counter party and general economic conditions are analyzed before selecting one of the options. The downside of acquiring financing through issuance of equity is that the procedure is quite complicated as compared to acquiring funds by approaching any bank. In most cases, a loan is acquired from any bank or financial institution by filing an application for the sanctioning of the loan. The bank or any other financial institution, after evaluating the necessary details such as credit history, financial outlook for assessing the ability of the entity to repay the loans in future, and the purpose of the project for which the loan application was filed, sanctions the loan. Whereas in the case of raising finances through issuance of equity shares, the company has to fulfill several requirements such as issuing a predefined number of shares, issuing shares to the existing shareholder in proportion to their existing shares and appointing a financial advisor for conducting a due diligence of the entity’s operations. Although these statutory rules and requirements are enforced by the relevant authorities in order to safeguard the interest of the organization and general public, complying with them can be quite troublesome when the requirement of the fund is urgent. References [1] Andreas Charitou, E. K. (1991). An empirical examination of cash flow measures. ABCUS, Vol.27 Issue1 p51-64. [2] Arnold, G (2007). Essentials of Corporate Financial Management. 3rd ed. Harlow: Pearson. P. 341. [3] Arnold, G (2007). Essentials of Corporate Financial Management. 3rd ed. Harlow: Pearson. P. 368 [4] Arzac, E. (1986). Do your usiness units create shareholder value? 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