“As the size of a business grows, the percentage growth it enjoys must inevitably decline” The Law of Large Numbers
Google (GOOG) released results last Thursday and the quarter was by all accounts, outstanding. Yet shareholders got killed. What happened? The only 100% true Law of
Investing ran up against excessive epectations.
Since it has been just over a year since my first Google post on its valuation and about 8 months since the last one. I thought now would be an opportune time to revisit the topic.
For Q4, Google said profit grew 17% to $1.21 billion, or $3.79 per share, on revenue of $4.83 billion. Analysts expected profit of $4.44 per share on revenue of $5.43 billion. Traffic growth dropped to 37% in the fourth quarter from 55% in the third, despite a market-share gain. Nothing wrong with those number but, when the expectation is for far more, shares get hit, hard.
The Lemmings:
Analysts, who only in the summer and fall were tripping over each other to have the highest price target for shares, are now doing the same to reduce them. Remember the $1000 price targets?
Jefferies & Co. analyst Youssef H. Squali downgraded the company to “Hold” from “Buy” and slashed his price target to $600 from $725.
Lehman Brothers cut its price target for Google to $644 from $714.
RBC Capital Markets lowered its target to $675 from $725.
Over the past year after my post, when shares sat around $500, they have dipped as low as $450 and ran up as high as just over $700. Now, a year later on Friday they closed at $515, 3% above where they sat a year ago.
Did management screw up? No. Could they have done something different to achieve greater growth? I think you would be hard pressed to find investors in many companies that earn over $1 billion a quarter complaining about 17% growth.
This is a simple story about unrealistic expectations. Period.
Now, the bad news. At $13.28 a share in earnings the past twelve months, at $526 a share, they are trading hands at 40 times earnings(last year they were trading at 60 times). Earnings that look to be growing under 20% now going forward. Now, while 17% growth at a company the size of Google is fantastic, it sucks when investors are pricing in almost twice that in the shares.
I think we may be having the same conversation next year…
Disclosure (“none” means no position): None
