Last post, I decided I wanted to own Google and I understand the company. It's got a lot of moat and tested management. But I've got to figure out the value. Here's how I do that. Its step #5 of the 7 step YUMMMMY analysis:
5. Margin of Safety: No matter how wonderful the company, you gotta get it at a great price to have certainty about your long term position. Even if you are trend trading you want to know the long term general direction of the stock price. So you have to know the value of Google's business. This is where the real risk comes in with a new company in a new industry - no track record means predictions are so full of debatable assumptions that the prediction of future cash is a dubious proposition. But I do dubious in my "Risky Biz" portfolio so here's how I look at Google's value: How fast can it grow it EPS for the next 10 years?
Estimates range from 17% to 50%. Let's use 30%. Why? It's growing at 50% average now. So, why not 30%? (No one knows anyway, which makes this a crap shoot, really!). And current EPS is running about $5 this year (based on the latest EPS announcement).
If you aren't on a website that will do this automatically, get out your excel spreadsheet and plug in =FV(30%, 10,,-5). Hit enter and you'll get about $70. That is our guesstimate of EPS in 10 years. Multiply that by some PE ratio. If it's growing at 20% a year at that point, it could have a 40 PE. 40 times $70 is $2800. That the stock price per share price in 10 years. I want to make 15% a year minimum. So I do an =PV(15%, 10,,-2800) and get roughly $700 a share current value - Sticker Price - the price I can pay and make 15% a year for the next 10 years if everything goes as planned.
Admittedly a shot in the darkishness. And since nothing goes as planned, I apply my Margin of Safety of 50% discount off of Sticker Price, and by my rules (for the Risky Biz) I can pay as much as $350 a share and still expect 15% a year. Since Google was selling for $200 and I finally 'got' it, I bought it. At this discount to the expectations, a lot can go wrong and still have this work out. In my terminology there is a lot of head room above this business's price in the market.
Next, a word about our partner, Mr. Market and the all-important (for lazy people like me) Yield calculation. Part III coming soon.
