A few days ago, we laid out a scenario in which Google’s stock could go to $2,000 a share over the next few decades. This drove some observers to declare us “irresponsible”–in part because they assumed we meant Google was worth $2,000 today (It isn’t: something that will be worth $2,000 in 20 years is only worth a fraction of that value now, with the exact fraction depending on the discount rate).
But here’s the other side of the coin: The fact that Google could be worth $2,000 in 20-30 years also reveals how shockingly expensive the stock is right now.
GOOG is currently trading at about 60X 2007 estimated Free Cash Flow (FCF) of about $3 billion. That is a big multiple, considering that many big companies trade at 20X-40X or less–one-third to one-half as much. Translation: If something were to happen to make investors think of Google as not “Google” but “a big company with good growth prospects,” the stock would drop to $200-$300.
Even if Google maintains its aura of Google-ness for the next 20-30 years, moreover–which it almost certainly won’t (what market darling ever has?)–the company will have to post heroic numbers just to justify today’s stock price, let alone $2,000.
Awesome Google Performance = 6% Long-Term Return
Let’s say Google grows cash flow at an average of 10% per year (3%-4% better per year than average, which is extremely difficult to do over many decades). Let’s say that Google’s FCF multiple gradually compresses to a more normal–but still Google-like–level of 40X (for perspective, Microsoft’s is half that). And let’s say that Google’s share count “dilutes” (through acquisitions, compensation, etc.) at a modest rate of 1% per year, which assumes that Google will use some of that massive cash flow to buy back shares.
Under these conditions–40X FCF multiple, 10% FCF growth (to $20 billion by 2027), and 1% share dilution–Google will trade at about $2,000 in 2027, 20 years from now. That sounds nice, but considering that the stock is already trading at $600, it’s not an impressive annual return. Specifically, it’s a return of about 6% annually–less than you should be able to get from the stock market overall and only a point better than a Treasury bond. (See this page for the numbers).
(It’s the multiple compression that does it. If you can persuade yourself that Google will be the one company in history that maintains a 60X FCF multiple in perpetuity, you’ll be fine. But just remember all those Microsoft investors in the mid-1990s who persuaded themselves of something similar).
Conclusion? If you’re a long-term investor (i.e., not someone who is trying to capitalise on Google’s current momentum ride and then get out at the top), you should sell your stock and buy an S&P 500 fund. You’ll still own Google, but in a highly diversified portfolio, and you should get a better long-term return.