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Google to touch 2000 $ !!!

G


Saw this recommendation on google. With google crossing 450$, I think analyst are tripping over each other in raising their price targets.

Gives me a feeling of deja-vu – remember year 2000, right after the internet bubble burst – when the conventional thought was that companies like e-bay, CISCO could not go down, because these companies had solid business models, were dominant in their industries and had a fantastic future ahead of them.

The recommendation also notes the following

Stahlman said he reached his estimate for $2,000 a share using a multiple of enterprise value, which adds market capitalization, preferred equity and debt and subtracts cash.
That’s based on the 6.2 multiple commanded by Redmond, Wash.-based Microsoft Corp., the world’s largest software maker and the company most often equated with Google as a competitor and model, he said.

Wow !! how can google be equated with microsoft ?? Don’t get me wrong …google is a great company and I love google product (I cant think of a day when I have not used the search engine). But google is not a monopoly by any stretch of imagination (which microsoft was for quite some time for OS and office products). Going forward the competition is only going to increase and I cannot think of goggle controlling the internet the way microsoft had a lock on the desktop.

The analyst predicts a sale of 100 billion some time in the future (does’nt say when) and the price of 2000 gives google a Mcap of 0.5 trillon dollars (500 billion !!!). Assuming google is doing extremely well even then, and has a Net profit margin of 20 % (current is 25 %), which I think is not very likely (but still lets assume for the sake of it). The PE at that time would still be around 25.

How many 100 billion dollar companies can grow at above average rates ?
How many 100 billion dollar companies have a net profit margin of 20 % or higher in a global market and can sustain it ?
How many 100 billion dollar companies have growths high enough to justify a PE of 25 ?

“Two things are infinite: the universe and human stupidity; and I’m not sure about the the universe.” – Albert Einstein

update : 01/20/2006

read views on google from bill miller. According to him the value of google could twice of the current price. At the same time following comments from him are worth noting

He said Google’s (Research) market-implied growth rate is about 28 percent. Consensus numbers for the company point to a 5-year growth rate of 33 percent to 35 percent, which then slows over the next 12 years to that of the overall economy, he said.
“The theoretical value of Google is still substantially higher than the market price. So the theoretically justified market cap under those assumptions is in the $240 billion range,” Miller said earlier this week.

Miller, who takes a long view on stocks and has low portfolio turnover, said there are still many unknowns about Google. Many companies start with great promise and then something goes awry and they disappear, he said.

Another topic at the bull session was whether Google’s users were “locked in” to its model, the way customers of Microsoft’s Windows operating system are, said John Miller, an economist at Carnegie Mellon University.
“Suppose you do have the best search engine. The big question is how sticky are the users,” he said.
In theory, customers could easily use a search engine other than Google, but Bill Miller said the fact that Google’s market share is stable suggests that a “psychological lock-in” driven by brand loyalty is keeping them coming back. (emphasis mine)

Thoughts on valuation approach for Banks

T



I have been reading shankar’s blog and left a few comments on his post about valuing a financial institution (like a bank or FI etc).

Shankar left me the following comment

Rohit, help me in arriving at a sustainable valuation model for banking sector. Debt recap / NCA will not work here. I can only think of P/E ratios but then this works on the whims and fancies of interest rates. Any guesses?

Its always easier to figure out what does not work v/s what does. That said, I have tried to come up with a valuation approach for banks and such lending institutions.

So here goes –

To start with let me try to list the reasons why valuing a bank is different from any other business

  • Role of cash: Cash for a bank is equivalent to raw material and is used for creating the Product – Loan / mortage etc. For other businesses, cash serves as a lubricant (for lack of better word) to run the business. Hence for most businesses, cash is held for liquidity purposes. For banks, cash or equivalents is held as a raw material itself.
  • Free cash flow: Free cash flow (after considering Capex) can be calculated easily for most businesses. Difficult to do for banks as their assets are not really the building / equipment etc. Assets are mainly the loans/mortages/ investment made out of cash. A business in absence of opportunities can return the cash to the shareholder. For a bank, the amount of free cash is not dependent on the opportunities itself. A bank has to maintain certain liquidity based on statutory requirements such as the risk profile of the assets.
  • Role of book value: for most businesses, book value is an indicator of money invested. But may not be a big indicator of the instrinsic value. For banks, book value (net of impaired assets) is much more important indicator of intrinsic value
  • Risk: Bank by their nature are risky businesses (I have read comments by buffett / munger to that effect). Any business which has a leverage of 10:1 (which banks do), can fall apart quickly due to mangerial mis-steps

My typical approach (which in my opionion is not sufficient) to value banks has been

  • P/B ratio – I try to look at the relative valuation through this ratio. A high quality bank (in terms of operational efficiency, NPA etc like HDFC bank) would sell at higher P/B ratio. It is important to figure out the correct book value (preferably book value net of impaired assets)
  • Long term return on equity – Higher the better, provided the bank is not making risky loans
  • % of Net interest income to total income – Would want fee based income to be a higher proportion of the total income. Fee based income is typically less volatile and has low risk.
  • Operational efficency – higher the better
  • Presence of competitive advantage through – Distribution network, brand and quality of management etc which will allow the bank to earn higher than average ROE without undue risk

So effectively I do not have a quantitative (discounted cash flow type) approach to value banks. However I have tried to use a relative valuation approach. At the same time, according to me banks are risky businesses. One can never be sure what is the risk in the loan portfolio / derivative portfolio of a bank (you just have to trust the management). As a result I try to look for a higher margin of safety. I typically try to buy only when the bank seems to selling between 1-2 times book value provided the bank is looking good on the other factors.

Please share your approach/thoughts on valuing a bank. It would help me/others in developing a better approach to valuing a bank or any other financial institution.

Stay away from the stockmarket ?

S

Found this post on mark cuban’s Blog

The Stock Market is for suckers….

I agree with mark’s basic premise which is that one should invest in the stock market only if one has an edge. However I do not agree completely with mark’s extreme view that the stockmarket is a place for suckers and there is always sucker on one side of a trade (although a lot of times there is one). The stockmarket is not a zero sum game and if one can avoid the extremes emotions of greed and fear, then one can get a resonable rate of return. Even on a trade, the buyer and the seller need not be a sucker. The seller may not be comfortable with the risk associated with the stock, may have achieved his targeted return or could be selling for some personal reason. The buyer on the other hand may have a similar view point, but could more comfortable with the risk on the stock, or could be hedging his position on some other stock.

I would say as an individual, I can have the following edge over the market

  • long term view : If I have long term view and can think beyond the immediate short term view point of the market, then I can find some good long term investment opportunities. For ex: FMCG in 2004 and early 2005 were good investment opportunities when the market was bearish about the short term outlook of this industry.
  • Investing in one’s circle of competence: As charlie munger’s says, it is not in human nature to be an expert in everthing. But if one works hard at it, then one can become an expert in a few areas. For me my circle of competence is limited to FMCG, industrial and a few other industries. So as long as I limit myself to these industries I should do fine. Ofcourse it means that the number opportunties are sometimes limited if these sectors are overvalued. But then as an individual one has the luxury of investing only when the opportunity is right.
  • As an individual investor, I have the luxury of being out of the market when I don’t find any values. A proffessional investor cannot do that

But at the same time, if one strays from his circle of competence and gets swept by greed or fear, then I think it is closer to gambling than investing (where the odds are against you )

Mark talks about technology investing in his post. Substitute ‘technology’ with any industry which is outside your circle of competence and I think the result would be the same. I think if one does not invest the required time to develop a deep understanding of atleast a few industries, then it is difficult to get a return higher than the market.

Some thoughts on banks and their retail portfolio

S

Found an interesting view on indian economy from the ‘Morgan stanley GEF’ website

Some interesting observation in the article

We believe that a large part of the recent growth in industrial production and to a lesser extent services sector growth has been driven by cyclical global factors. A sharp fall in real interest rates since 2000 has encouraged both the government and households to borrow aggressively.

And

Acceleration in consumption growth has largely been driven by a rise in borrowing rather than income growth. Strong domestic consumption has been one of the key factors pushing the combined growth of industry and services sectors, which has averaged 9.3% over the past four quarters.

Second, rapid growth in leverage is also resulting in more credit risk in the financial system. Our banks team sees a rising credit risk building in the system as Indian households have leveraged significantly above the fair level that is supported by the current trend in per capital income. The central bank also relayed similar concerns.

The above makes you think about the valuation of banks which are showing strong profits and very low NPA. For Ex: ICICI bank has brought down NPA from 4%+ to below 1%. What are the kind of risks these banks have on their balance sheet due to their aggressive retail loans ? Somehow retail loans are now seen as low risk, high return and high growth area for most of the banks. As a result there has been a substantial growth of the retail portfolio. Maybe the overall risks are low (atleast the market has priced the bank stocks accordingly). The problem with bank loans is that these problems can remain hidden for a long time. As buffett as ‘Its only when the tide goes out, that you realise who has been swimming naked’

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