Here’s a wake-up call for every investor that was disappointed in Google’s recent financial numbers – you’re expecting the impossible out of the company!
According to Fortune, it’s virtually impossible for Google to live up to the expectations of its current stock price. A quick explanation. When you buy a stock, you shouldn’t buy based on the company’s current valuation or profits. Instead, most investors value a stock based upon the expected future value.
Specifically, a stream of future profits, in particular what’s called economic profit or economic value added (EVA), the dollar amount by which return on capital exceeds the cost of capital.
Ok, still with me? Fortune asked analysts to calculate how much Google would have to grow, in order to match the expectations set by its current stock price.
To live up to the expectations embedded in its current share price, Google would have to increase its EVA, which was $2.4 billion for the past four quarters, by $2 billion annually this year, next year, and every year into the future – forever. So Google’s EVA next year would have to be $4.4 billion; in five years it would have to be $12.4 billion, and so on.
As Google continues to mature, it can’t possible maintain this kind of growth. As Fortune points out, it doesn’t necessarily mean Google’s stock is overpriced – if all companies were valued by EVA we wouldn’t need brokers and analysts – but it does suggest that the company may continue to see a correction in its share price.