What's Google Worth?

Nearly everyone agrees that Google is a great company. But at what price? The market isn't sure. Shares have lurched from a high of $475 in January to $338 in mid March. Analysts aren't much help. Their target prices range from $255 to $600.

Google's 41% share of the U.S. online-search market leads the pack and is growing, and it collects $6 billion of the $500 billion spent worldwide each year on advertising. So it might seem a good bet that the company will grow more than enough to justify whatever price you pay today. But some Cisco investors must surely have felt the same way when they paid $80 for shares of the world's leading networking company in 2000, after five years of astonishing growth. Cisco now trades for $20.

Still, Google looks relatively inexpensive based on several measures of value. For example, it trades at 38 times the $8.89 per share that analysts, on average, expect the company to earn in 2006 and 28 times next year's expected earnings of $12. That's cheap compared with Yahoo's price-earnings ratio of 57 for this year and 42 based on next year's earnings. Piper Jaffray analyst Safa Rashtchy says market-leading technology companies such as Google can justifiably trade at P/Es ranging from 50 to 60. His $600 one-year target price assumes 2007 earnings per share of $11.98 and a P/E of 50.

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Another way to measure Google's value is using the PEG ratio, which compares the P/E to expected long-term profit growth. The faster the growth, the more justifiable a high P/E. In Google's case, the G -- the expected growth rate -- is 31%. So its PEG is 1.2 based on this year's earnings forecast and 0.9 based on next year's. Generally, a PEG ratio close to one is considered cheap. Goldman Sachs analyst Anthony Noto says a leading growth company like Google should trade at a PEG of 1.5 to 2. His $500 one-year target is based on a PEG of 1.8. By contrast, Yahoo's PEG is 2.2 on '06 profit estimates and 1.6 on next year's.

Better measure

If you want to take your analysis to a higher level of sophistication -- and complexity -- forget the P/E. Because various accounting maneuvers can distort reported earnings, many analysts rely on a purer measure of profitability that goes by the acronym Ebitda, or earnings before interest, taxes, depreciation and amortization. Many analysts also believe that enterprise value -- a company's stock-market capitalization plus outstanding debt minus its cash holdings -- is a better measure than stock-market value alone of how investors value a company.

So if you divide Google's enterprise value (think of it as its price) by its Ebitda (think of it as a proxy for earnings) based on '06 estimates, you get 23. The number by itself is meaningless, but compared with Yahoo's 24, it seems to suggest once again that Google is reasonably priced. Citigroup analyst Mark Mahaney argues that since Google has the higher estimated growth rate (Yahoo's is 26%), its EV/Ebitda ratio should be higher. He sees Google reaching $471 in a year.

Why does Google trade so far below many analysts' target prices? Perhaps it's because much of its share price represents the promise of future earnings, and investors seem to have lost confidence lately that the company can live up to such lofty expectations. But at today's share price, odds are that a show of faith in Google will eventually be rewarded.