UPDATE: Despite another attempt to debunk the Comscore report this morning, Google’s (GOOG) taking it on the chin again. The latest valuation in our Google Valuator spreadsheet below:
EARLIER: We’ve been waiting patiently for years for Google to go on sale, and thanks to the body blows the stock has taken in recent weeks, we’re finally getting there. At $460, Google still isn’t “cheap,” but it’s getting to a point where the downside isn’t so terrifying.
Specifically, Google is now trading at about 30X run-rate free cash flow. Unless free cash flow gets hammered, we doubt the stock will drop below 25X (the long-term power of the franchise is just too compelling for investors to completely throw in the towel). Last time we checked in on valuation–at $525/38X–the floor was still dizzyingly far away, but we’re now getting there.
Free Cash Flow vs. EBITDA and P/E
Why do we look at free cash flow instead of EBITDA or Earnings? We find Google’s non-GAAP P/E less meaningful than it would otherwise be because of the significant percentage of option cost that the company is still expensing (which most analysts ignore).
EBITDA, meanwhile, is a meaningless metric for companies that have significant capital expenditures, which Google now does. (Wait, do we mean EBITDA is a meaningless metric for the entire media and cable industry, which clings to it like a crutch? Yes. We suspect “EBITDA” was invented by brilliant early cable industry titans who hoodwinked analysts into thinking that cash-flow-before-required-expenses was meaningful. It isn’t.)
Will Google’s FCF Get Crushed?
If Google’s revenue flattens (or, God forbid, drops), will FCF get slammed? It might, especially for a couple of quarters. We believe, however, that Google’s huge capital spending in recent years has been the direct result of having operating cash flow coming out its ears. If operating cash flow shrank, therefore, we believe Google would be able to significantly cut back on CAPEX, thus preserving cash flow.
Going forward, moreover, as Google continues to grow (perhaps on the other side of a recession), we think there’s room for CAPEX to decline as a percentage of revenue. This would allow FCF to grow far faster than revenue.
Bottom line, we don’t think Google’s free cash flow margin is a “peak margin.” We believe the company has been spending like a drunken sailor. If times get tough, we think the company would be able to cut back, thus boosting its FCF yield.
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