Top-down Approach to Stock Valuation for Google Stock - Term Paper Example

A top-down approach to stock valuation for Google Stock Section Investment summary I would recommend the buying of Google stock. The company's current strategy would probably increase their chances of gaining strategic alliances, and make them a more attractive partner. As other companies see that Google is no longer going head on with partners, they may be more willing to cooperate with Google as well. Especially in developing markets, such strategic partners can offer Google a huge advantage, which will translate to increased value of Google's stocks . Section 2: Overview of the company Google inc. is a company that offers a wide range of products and services to online users. The most popular service the company renders is their search engine named Google. The Google search engine uses PageRank, Algortihms, Link Measurement, and Profiling as part of its objective to deliver the most accurate and most relevant results to the searcher. Google also offers a very successful email product called Gmail. Gmail is unique in that it allows the email account holder much more free space (7GB) than the average free email client. In my experience, Gmail is an exceptional email client as it provides many more services than the standard email. Google Maps is another successful application in that it is not just an average web mapping system. This advanced mapping system offers satellite imagery of most urban cities in the US and around the world. It also can be integrated with many mobile phones, which allows for a GPS mapping system directly on the phone. These features allow its users to find information and easily share it to anyone in the world. With the amount of traffic Google receives on a daily basis, Google has to have some kind of strategy to generate its revenue. One of Google's main sources of revenue is advertising. In 2007, advertising accounted for 99% of Google's revenues. Google implements two main advertising products which are AdSense and AdWords. AdWords is Google's flagship advertising product and main source of revenue ($16.4 billion in 2007). AdWords offers pay-per-click advertising, and site-targeted advertising for both text and banner ads. The AdWords program includes local, national, and international distribution. Section 3: The macroeconomics Google competes to attract and retain relationships with users, advertisers and Google Network members and other content providers in different strategies. Google competes to attract and retain users of its search and communication products and services. Most of the products and services that Google offer to users are free, so they do not compete on price. Instead, they compete in this area on the basis of the relevance and usefulness of their search results and the features, availability and ease of use of their products and services. Google has been an outstanding company in the marketplace ever since its inception and it continues to be and deliver exceptional service to the global market. The move into public ownership brought about more benefits to its employees as well as present and future shareholders. The founders of Google felt that the standard structure of public ownership might jeopardize the independence and focused objectivity that has been apart of Google's past success. Google's leadership team wanted to preserve this aspect of the organization, so they implemented a corporate structure that is designed to protect Google's ability to introduce and retain its most distinctive characteristics. In 2007 and 2008, cash from Google's financing activities totaled $403.1 million and $87.6 million (Google Inc. 2009). Cash from financing activities is cash flow that takes place between organizations and stockholders and includes loans from bondholders and other creditors (Financial Education 2007). According to Google's numbers, the company is under no risk since the company does not rely solely on outside sources to generate its cash flow. Cash flow from Google's investing activities negatively increased in 2008 as it did in 2007. In 2007, the company had net investing activities of ($3.68) billion and ($5.32) billion in 2008 (Google Inc. 2009) - a negative increase of $1.6 million. Based on Google's history and the company's ability to generate cash flow, the negative increase in investing activities may be attributed to long-term investments and purchases that will ultimately generate cash flow. In comparing the 2007 and 2008 fiscal year of Google to Yahoo!, it appears that Google still remains Yahoo's top competitor as in past years. Over the past two years, 2007 and 2008, Yahoo! has managed to generate its cash flow from its operations. The company's cash flow from financing activities of $322.4 in 2008 million and $1,442 million in 2007 compared to its cash flow from company operations (Yahoo! Inc. 2008) is an indication that Yahoo! is following the financial pattern of Google and is not depending on it financing activities to generate its cash flow. Business Changes that occurred may have altered the use of cash from one year to the next. The financial statements of Google have showed that the company has had steady growth. Revenue and profits have increased, as well as administrative, research and development expenses. Slight operating expenses have increased from 2007 to 2008. The cash flow statement shows cash from investing activities remained in the negative only greater. Additionally, more taxes were paid in 2008 than in 2007; however, there was no change in net cash. The financial statements of Yahoo!, shows that short-term and long-term investments have drastically increased. The cash flow statement shows that Yahoo! issued or repurchased capital stock. Google and Yahoo! are constantly striving to beat out competitors using innovation and new products and services. Therefore, both companies invest heavily in research and development. Discussion of Cash Generated in a Sustainable Manner. The use of ratios and trend analysis alerts viewers of Google's financial health. Google has maintained its profitability in the double-digit percentiles, although it slightly increased its debt. In order to Improve Cash Flows Keeping track of any cash that flows of any company is important if managers want to achieve financial goals. While the task may require a daily count of receipts, there are several recommendations a company can improve its cash flows. Before any company tries to improve its cash flow, it is important that managers determine how cash flows through the company. Inflows are cash collections added to the company's existing cash while cash leaving the company are its outflows (Toolkit Media Group, 2009). Cash flow will improve when companies collect cash owed to them. The longer cash stays uncollected, the less cash the company has to reinvest. Companies can offer incentives such as free specialized services or discounts on products. This move will encourage consumers to pay debts on time and as agreed. The founders of Google wanted to make sure that in the transition process to public ownership it would be difficult for outsiders to take over or influence Google. The corporate structure would make it easier for the management team to follow the long-term innovative approach. The Google's stock was distributed with Class A common stock having one vote per share and the Class B common stock held by the current shareholders has 10 votes per share. The purpose of this structure has left the Google team of Sergey and Page with increasingly significant control over the company's decision and fate, as Google shares change hands. With the completion of the IPO, Brin, Schmidt and Page will control 37.6% of the voting power of Google, and the executive management team and directors as a group will control 61.4% of the voting power. This move will give new investors access to full share in Google's long-term economic future. However, they will have little ability to influence its strategic decisions through their voting rights. The move to dual voting structure was considered unusual for technology companies however; it is common among media businesses and has proven to be very successful. The owners of Google believe that a dual class voting structure enables Google, to continue its success as a public company. They have been successful as a private company and they expect this to continue. Investors were concern that this type of voting structure would only be of benefit to Google, but the corporate team made this decision after thoughtful consideration and has confidence that it would be in the best interest of all Google's shareholders. The Google executive team has also expanded the board of directors to three additional members and they are of the view that the team at Google is a world class management team. This team is expected lead the organization forward into the future. The management team has stability and looks forward to retaining its cultural uniqueness while attracting and retaining talented persons that will affect the growth of the organization. The Google's organization thrives on taking the unusual approach to business and in the course of the IPO process demonstrated this once again by taking the an auction approach to distribute their stocks. The risk in this approach was that if there were not enough bidders or if people bid lower the IPO price will be low External and Internal Factor Evaluation The Price/Earnings (P/E) ratio is a company's price-per-share divided by its earnings-per-share. Google's P/E Ratio (TTM) is 25.96 meaning it has a relatively high valuation. The Price to Sales (P/S) Ratio is the stock price (total market cap) / total sales (revenues). Generally, the lower the ratio, the more attractive the investment. As easy as it sounds, price-to-sales provides a useful measure for sizing up stocks. Google's P/S Ratio is 5 which is really not so great. Google's P/B Ratio is 3.83, which is greater than the industry and sector. Its competitor Yahoo has a P/B Ratio of 1.57 which is below the industry standard. And Microsoft, another one of Google's competitors, has a P/B Ratio of 4.43 which is above the industry standard. The Growth Rates in terms of Sales TTM vs. TTM 1 year ago for Google is 31.35. This is a healthy number in terms of growth; it means that sales have gone up 31.35% since the same time 1 year ago. The Sales TTM vs. TTM 1 year ago for Yahoo is 3.43, and for Microsoft is 7.05. This means that Google has had the most growth in sales within a 1 year TTM than its other two main competitors. I think Google should continue to focus its concentration on current markets and also on its current product development strategies. Google remains in an excellent strategic position. Section 4: The industry Google is doing very well financially compared with other competitors such as Yahoo. The current ratio, quick ratio and total assets turnover ratio of Google is better than other companies or at least at par with those for other competitors. Current ratio: At the end of 2009, Google's Current ratio was $8.77 million and $8.49 million at the end of 2008 (Google Finance, 2009). In comparison, Yahoo's current ratio was $1,705.02 million at the end of 2009, and $1.41 million in 2008. (Richardson, Chris 2007) Quick ratio: The financial statements of both Google and Yahoo! show zero inventories for 2008 and 2007. Therefore, since the only difference in the current ratio and quick ratio is inventories, then the current ratio and the quick ratio are equal in this case. (Richardson, Chris 2007) Total assets turnover ratio: The total assets turnover measures the efficiency of a company and its effectiveness to produce income from reinvestments of dollars back into an organization. In 2008, Google had an estimated total asset turnover of about 69% and in 2009, Google had an estimated total asset turnover of about 59%. For the two-year period combined, Google generated an average of 64% return on its money, which indicates that Google does possess the assets necessary for generating earnings. Moreover, total assets turnover ratio, P/E ratio and book value/share ratio of Google is also better than the other companies. However, Google does have its weakness. As we can see, profit margin on sales of Google is slightly lower compare to the other two. However, Google's price/CF ratio is slightly lower than Yahoo, but is significantly lower than Microsoft. Google is aiming at maintaining their position as a leading innovator. Source and Application of Funds Google, in preparation for its IPO listed its shares on the Nasdaq Stock market as they provided details for the unconventional IPO process. Charles Schwab and Co. Inc clients also became qualified for the IPO auction. Google chose to offer its shares in an open auction. Google's initial IPO was targeted to raise about $2.7 billion for the organization. However, the price of the IPO was reduced substantially prior to the auction taking place. Google envisioned that for one year it would allocate stock-based compensation charges for grants to its employees. This figure is expected to be about $377 million. (Google 2006) Into the Future Despite all the challenges Google faced at the beginning of their IPO, they have overcome these challenges and moved forward with the public confidence. Google continues to be a competitive organization. Although there has been a decrease in its stocks in the last year, predictions are that this will not continue. Google's stock is expected to increase, and the company will remain a viable force in the technology industry. Therefore, those investors waiting for a stock-split will have to wait a little longer. Google will continue to move forward to its long-term goal of services that significantly improve the lives of people who make Google their primary search engine. Section 5: The firm Proposed Valuation Model 1. The target price is determined by the Gordon constant dividend growth model 2. Assumptions Retained earnings represent the only source of financing The Rate of return is constant Cost of equity remains constant and is greater than growth rate The company has perpetual life The closing price of Google as at April 15 2010 was $595.30 the company has market cap of $189.29 billion. This stock price fairly reflects the firm's fundamentals. "Google Inc (GOOG), the Internet search engine said first quarter revenues rose 23% to $6.78 billion from $5.51 billion a year ago. Net income in the quarter rose 41% to $2 billion or $6.06 per diluted share compared to net income of $1.42 billion or $4.49 per share last year. Google Inc revenue rose 23% and net income rose 41%. Intuitive Surgical, Inc revenue rose 74.4% and net income rose 203.5%. Google Inc, in the last one year traded as high as $629.51 in January 2010 and as low as $364.16 in April 2009." (Mita Yagnik 2010) (1) ROA=Profit margin X Total assets turnover= (Net income/Sales) X (Sales/Total assets) (2) ROE=ROA X Equity multiplier= (Net income/ Total assets) X (Total assets/Common equity). So, ROE=Profit margin X Total assets turnover X Equity multiplier. Projecting the 2010 financial status, if we holding the profit margin and equity multiplier constant as 2009 (profit margin=0.03, equity multiplier=1.59). When we pursue a 50% sales increase in 2010, this will provide us a total sale of 12,418,500,000 USD. After the comparison of the company's financial ratio analysis to other companies, it can be seen that Google is doing a good job. This can also be seen in the fact that from year 2003 to 2009, Google's revenue increased from 1,465 Million to 3,189 Million USD, which increased 117 percent while there was a 277 percent increase in Net Income. Also, revenue increased 625 percent compared with revenue in 2008, while Net Income increased 300 percent. The company's current and quick ratios in 2009 are higher relative to its 2008 current and quick ratios. Both ratios are quite high though, which means Google has strong competitive financial position. This valuation model provides the best fit for valuing the firm, as it is quite clear that Google's strongest service is its search engine. Besides, all Google's services, except for search not being used much, they hardly bring in any revenue. Google is investing in these services though, making them dogs, according to the Boston consultancy matrix. Therefore, Google may be better off eliminating these services, and fully focusing on its search engine. If the company does this, they would be best off using a concentration strategy, and redirecting all resources to the improving of the search engine. They could go into horizontal growth, forming strategic alliances with other large websites. Functional strategies must also be changed in order to follow such corporate and business strategies. For example, the research and development department would no longer be able to use its hit and miss strategy. Rather, researchers would have to focus on one specific task. Also, the company would be better of becoming a technological leader, rather than a follower, since that way there would be less risk of being passed by competitors. The only negative effect such a strategy might have is on the culture; it may become less innovative. Because Google would start to cooperate with other websites, the need for any innovation outside of the search engine may become less necessary. If the company thinks a new service may be needed, they could just join forces with another company, rather than creating the new service by themselves. Since Google's culture relies heavily on innovation, which stimulates employees, the loss of the innovation may make Google a less attractive place to work. However, If Google continues to stimulate innovation, they may be able these innovations to their strategic partners. Works cited Brealey. R.A., Myers. S.C., Marcus. A.J., (2004) How Corporations Issue Securities Fundamentals of Corporate Finance, 4th edition, pp 366-390 Gibbons R. (2007). Google's Ghoulish Trick. Retrieved from http://www.fool.com/investing/general/2004/10/27/googles-ghoulish-trick.aspxterms=Google++Trick&vstest=search_042607_linkdefaultHistory of Google La Monica, P.R. (2007) Google gets 2.7 billion IPO. CNNMoney.com. Retrieved from http://money.cnn.com/2004/04/29/technology/google/. La Monica, P.R., (2007). Google Jumps 18% In Debut. CNNMoney.com Mita Yagnik (2010) Google, Intuitive Surgical Net Rises. DAILY EARNINGS. Retrieved from http://www.ticker.com/page=daily_earnings&story=Google,%20Intuitive%20Surgical%20Net%20Rises&id=37929 Richardson, Chris. (2007) Google IPO Roundup. Webrpronews.com Albrecht, W., Stice, J., Stice, E., & Swain, M. (2005) Accounting: Concepts and Applications. Mason, OH. Thomson. Brealey, R.A., Myers, S.C., & Marcus, A.J. (2004) Fundamentals of Corporate Finance New York, NY. McGraw-Hill/Irwin Read More