Saturday, February 4, 2006

podcasting advertising market

As business models related to the ubiquitous internet rely more and more on advertising, I thought that an interesting exercise would be to understand the implied growth rates in Google's stock. Afterall, Google is the gorilla of all advertising driven business models.

- Current price per share of $369
- Earnings per share of $5.02
- Beta ranging from 1.25 to 3 (since it is such a new offering it's best to do some sensitivity around this value
- P/E ratio in 10 years between 20-80

- If you run through the numbers you come up with the following sensitivity table on implied growth rates of Google's stock assuming different Beta's and P/E ratio in 10 years:
1) Taking Beta constant at 2 and changing the P/E ratio growth rate varies from 25% to 9% (P/E ratio of 20 and 80 respectively).
2) Keeping the P/E ratio constant at 30 (Microsoft's multiple after 10 years), growth rate varies from 18% to 23% (Beta of 1.5 to 3 respectively).

I would think that it is very unlikely that in 10 years Google will maintain its current P/E share of over 70, so assuming that it follows the record Microsoft has had (P/E of 30 after 10 years) and volatility somewhat more marked then the market (Beta value of 2) you are looking at implied double digit aggressive compound annual growth rate of 20%. So if you were to buy the stock today, it would have to grow at this rate in order for it to maintain its value, and it would have to exceed this growth rate for you to make any money. Now, earnings have grown 100% for Google in the last year, and with a few more years of such dramatic growth you might average out the less stellar results later in the lifecycle of the company to possibly still give you 20%. Note, however, that Microsoft ended up growing at rate of about 10%.

So the next question is whether Google's can capture revenue by diversifying into other offerings (subscription fees, wireless access, etc) and whether their current model of providing state of the art software supported through advertising revenue streams has more room to grow. To think about the second issue more precisely, you would need to consider the growth of the advertising market across the various segments that Google operates in (search) and growth in advertising from segments they are likely to expand into (mobile services, digital content aggregation, etc). You would also need to consider how this market is likely to be divided among other incumbents (Yahoo, Ebay, Microsoft) and new upstarts. Look for my thoughts on this market analysis in one of my future posts.

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