A reader complained that we’ve been nothing but negative of late–recession, Microsoft, Yahoo, newspapers, music, dying TV ads, etc.–so we’ll brighten your afternoon with some rip-roaring positivity. (And if you hate sunshine, see end of post for gloomier updates.)
Remember a couple years back when some analyst floated the idea that Google could eventually be worth $2,000 a share–and was ridiculed from coast to coast? Well, first it’s worth noting that Google is now almost a third of the way there. Second, it’s worth noting that $2,000 a share would mean a market cap of about $750 billion, which–given a reasonable time horizon–just isn’t that far-fetched.
Why? First, from a macro level, in every technology wave, the market leader usually ends up amassing more power, wealth, and market capitalisation than the leaders in the prior wave, often by a startling magnitude. The leaders in the last technology wave included Microsoft and Cisco, both of which peaked around $500 billion in market capitalisation…
Even a room full of bears would no doubt agree that there will eventually be a company that has at least a $1 trillion market capitalisation. So name one company that is better positioned than Google to one day have a $1 trillion market capitalisation.
What kind of cash flow would it take to support a more modest $750 billion market cap? ($2,000 a share). Assuming a 25x free cash flow multiple (generous), it would take free cash flow of $30 billion. That is one heck of a lot of free cash flow, especially considering that Google’s free cash flow next year will be about $4 billion. (For perspective, Microsoft currently has annual cash flow of about $15 billion, GE $15 billion, and ExxonMobil $35 billion).
On the other hand, $4 billion is a heck of a lot of cash flow, too, especially for a company that didn’t exist 8 years ago. Google is a lot farther along than Microsoft was at this age. And don’t forget the miracle of compounding.
If Google grew free cash flow at 7% per year, it would hit $30 billion in 30 years (and half of that growth would come effortlessly from inflation). If it grew free cash flow at 10%, it would hit $30B in 20 years.
Then there’s the fact that Google’s current free cash flow multiple is not 25-times, or 35-times, or even 45-times, but more like 70-times. Is that multiple sustainable? No. But if it fell to, say, 40-50-times, and Google grew cash flow at 10%, then reaching that $750 billion market cap would only take 10-15 years (at which point the company would still be a relative spring chicken of 18-23, versus Microsoft’s current 25).
And then there’s the market reality: As long as Google continues to eat the lunch of not only every major media company on earth but also the lunch of many technology companies (Redmond?), investors are going to continue to pay a major premium for the stock, and earnings are going to continue to grow, on average, faster than 10%. Plug in those assumptions, and, with luck and strong markets, the $750 billion market cap could be reached within 10 years.
Is this guaranteed? Of course not. It’s a thought exercise. Google could peak today and head for zero tomorrow and leave everyone who ever considered buying it at $600 wondering what on earth they were smoking. (And if it does go to zero, don’t come whining to us).
But since we have indeed been deluging you with negativity recently, we thought it was also worth presenting the upside. 🙂
*UPDATE: As I should have predicted, no sooner did this post hit the net than an angry mob of normally clear-thinking, open-minded folks instantly demanded my head. Why people get so exercised about this topic will never cease to amaze me. But just to state my position clearly: I DO NOT think you should rush out and buy Google. If you’re going to buy anything, buy an index fund. A longer response here…
*UPDATE 2: As an illustration of why “Google $2000!” is not actually particularly exciting, we ran detailed numbers and then calculated the annual expected return here. The bottom line: If Google goes to $2,000 in 20 years, you’ll earn a 6% return--less than you’ll probably make on the S&P 500.
*UPDATE 3: Here’s a sneak-peak at Google’s future stock chart. The key challenge for you, Mr. Google Investor: Figuring out when the company’s growth trajectory is going to change.