In the past few months, Google (GOOG) has gone from trading at 40X-50X free cash flow to trading at just north of 30X. Some of this is the result of recession fears, but most of it is the result of run-of-the-mill multiple compression as Google’s revenue and profit growth decelerate. This multiple compression happens to every great growth stock at some point, no matter how strong the company is.
Back in October, we ran a “sneak peak” of Google’s future stock chart (a.k.a., Microsoft’s stock chart for the past 20 years). In case you missed it, here it is again:
Note that Microsoft (MSFT) has continued to grow rapidly for the past 8 years, just not as rapidly as it did in the 1980s and 1990s. Over the past 8 years, Microsoft’s multiple has gradually compressed, to the point where it is now trading at only 15X free cash flow. Someday, Google will trade at 15X cash flow, too–though one hopes not for a long time.
What does this mean for the future of Google’s stock price? Unless search growth reaccelerates, or unless video, display, or mobile advertising causes Google’s overall revenue and profits to accelerate, the free-cash-flow multiple will likely settle in to about 20X-30X.
Google is still much earlier in its lifecycle than Microsoft, so unless the company’s prospects start to look bleak–like the 15X cash-flow eBay’s–we don’t expect the multiple to compress to 15X. But future stock-price appreciation will likely have to come from cash flow growth rather than multiple expansion, which will require a far more patient set of shareholders than those who have gorged on Google to date.
Google $2000? Still Reasonable
What does this mean for the Google $2000 scenario we outlined in October? No change. Multiple compression was one reason we suggested that the timeframe for Google $2000 was “one or two decades” (not a year, as some blogs have repeatebly implied). Google’s long-term cash flow growth prospects haven’t changed, in our opinion, but the amount investors are willing to pay for them has–likely permanently.
For a long-term investment like this, we’d love to have the potential for a 10X return over a 10-20 year timeframe–and with Google still at $450, we’re a ways away from that. But the more the stock falls, the more the near-term valuation downside is limited, and we’re now finally nearing the 20X-30X range that we expect will represent a some downside protection.
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