| Price Target: $16,578.90 | | | | In my model, Google can literally conquer the world. |
| Some of you will immediately recognize this headline | | | | With something like $9 billion in equity to start with, a |
| is a joke. For the rest of you, I was kind of hoping | | | | 12% return on equity, and the reinvestment of all |
| the ninety cents part would give it away. | | | | earnings in the business, Google would get awfully big. |
| If you’re reading this because you’re | | | | Don’t believe me? I know a 12% return on |
| interested in what I have to say about Google | | | | equity looks ridiculously low, but watch what happens. |
| (GOOG), you can stop now. I’m not going to | | | | In 2056, Google will be a $312 billion company. Of |
| say anything interesting about Google. Rather, | | | | course, the big question is: do I mean market cap or |
| I’m going to say something (that I hope is) | | | | revenue? |
| very interesting about the wonders of compounding. | | | | I mean profits! At a P/E of 15, Google would have a |
| Warren Buffett’s annual letter to shareholders | | | | market cap of $4.68 trillion. Yes, with a t. That |
| was released on Saturday. For now, I’m just | | | | same Google share that was quoted on Friday at |
| going to pull out one little nugget: | | | | $378.18 would be worth $16,578.90. Google’s |
| Between December 31, 1899 and December 31, | | | | EPS would be $1,105.26. You read that last part right. |
| 1999, to give a really long-term example, the Dow | | | | Each Google share would be earning three times its |
| rose from 66 to 11,497 (Guess what annual growth | | | | current (lofty) price. |
| rate is required to produce this result; the surprising | | | | So, what’s the catch? There are two |
| answer is at the end of this section.) | | | | problems with this scenario. One, in 2056, it’s |
| I knew what Warren was up to, and had some idea | | | | more likely Britney Spears and Kevin Federline will be |
| of the historical growth rate for the Dow, so I | | | | celebrating 50+ years of marital bliss together than it |
| guessed 6%. | | | | is that Larry Page and Sergey Brin will be celebrating |
| Here’s the answer to the question posted | | | | 50+ years of 100% retained earnings at Google. For |
| at the beginning of this section: To get very specific | | | | that matter, I’d say it’s more likely |
| the Dow increased from 65.73 to 11,497.12 in the | | | | Larry Page and Sergey Brin will be celebrating 50 |
| 20th century, and that amounts to a gain of 5.3% | | | | years of marital bliss together in 2056 — which |
| compounded annually. (Investors would also have | | | | is to say it isn’t very likely Google will be able |
| received dividends, of course). To achieve an equal | | | | to retain all of its earnings for the next half century |
| rate of gain in the 21st century, the Dow will have to | | | | (unless you know something about Larry and Sergey |
| rise by December 31, 2099 to — brace | | | | that I don’t). |
| yourself — precisely 2,011,011.23. But | | | | The second problem is much less amusing. You see, if |
| I’m willing to settle for 2,000,000; six years | | | | on Monday, you were to shell out the $378.18 for a |
| into this century, the Dow has gained not at all. | | | | share of Google, when the stock reached $16,578.90 |
| I wish I could tell you that my guess was close. But, | | | | in 2056, you’d be able to brag to Britney and |
| it wasn’t even in the right ballpark. The | | | | K-Fed about your annual compound gain of
drum |
| difference between a 5.3% annual gain and a 6% | | | | roll please
7.85%. And that’s before taxes |
| annual gain may look relatively small. In fact, the | | | | and inflation. |
| difference is not small. If, during the 20th century, | | | | Google would have a $4.68 trillion empire, and |
| the Dow had achieved a gain of 6% compounded | | | | you’d have an annual return of 7.85% - how |
| annually rather than a gain of 5.3% compounded | | | | can that be? |
| annually, on the eve of Y2K, the index would have | | | | Time turns molehills into mountains and mountains into |
| been sitting at 22,302.33. | | | | molehills. In the very long-term, growth that only |
| The rallying cry of the bubble years would have been | | | | earns ordinary profits leads to stocks that only yield |
| Dow 20,000. And what of Dow 10,000? The index | | | | ordinary gains. But, isn’t Google’s |
| would have added its fifth figure in 1987. | | | | (lofty) price the problem? It’s part of the |
| That’s right, if the Dow had achieved a gain | | | | problem. |
| of 6% compounded annually during the 20th century, | | | | However, it’s probably a smaller part than you |
| the index would have broken the 10,000 mark while | | | | think. Right now, Google is trading at about twelve |
| the Berlin Wall was still standing. | | | | times book. What would your return be if you |
| Over a century, that extra 0.7% really adds up. I | | | | bought Google at book value? 13.32%. That’s |
| recently wrote an email to a member of my family | | | | a good return (fifty years from now, it’ll |
| who had just had her first child. You would think that | | | | probably be considered a great return). Still, |
| blathering on as I do here each day, I would have a | | | | it’s somewhat unsatisfying. I mean, if you had |
| sea of investing advice to offer. In fact, I provided | | | | the prescience to buy a $4.68 trillion behemoth when |
| only a single drop: Time trumps money. | | | | it was just a $10 billion company (remember, |
| If you want to have more money than you will ever | | | | you’re paying book this time) all you’d |
| need, your best bet is to find a few places where | | | | get for your trouble is 13.32%. |
| you can deploy large sums of money that will earn | | | | Think of it this way. At $31.87 a share, 85% of your |
| good returns for a great many years, and will not | | | | purchase price would be backed by cold, hard cash |
| require you to share any of the spoils with Uncle | | | | and you’d be buying a stock with a P/E of 6.3. |
| Sam until you are done accumulating said spoils. To | | | | A P/E of 6.3 is insanely cheap. So, why would buying |
| do this, you will have to own a business either in part | | | | a stock trading at a P/E of 6.3 and growing earnings |
| or in whole. I’m an investor, not an | | | | per share at 11.4% a year for fifty years only yield a |
| entrepreneur; so, let’s stick to the economics | | | | 13.32% return? Where are the insane gains? |
| of becoming part owner of a business. | | | | Return on equity is the puppet master here. Take |
| It’s time to discuss Google. I have a price | | | | another look at the numbers. They’re doing |
| target of $16,578.90 on Google. Does that sound | | | | something strange; they’re converging. |
| reasonable? No. Well, I may have forgotten to | | | | Everything is getting closer and closer to 12%. Why? |
| mention this is a 50-year price target? So, does it | | | | Because that’s your destiny. If you buy a |
| sound reasonable now? | | | | business that earns 12% a year and you hold it long |
| Don’t answer. First, we need to see what it | | | | enough, guess where your returns are headed? |
| would take for Google’s share price to reach | | | | Here’s one last excerpt from Buffett’s |
| $16,578.90. Last I checked, each share of Google had | | | | letter. He’s writing about all businesses, but a |
| a book value of $31.87. Everyone says | | | | long-term holding in a single business works in much |
| Google’s a great business. They may be right. | | | | the same way: |
| But, I like all my surprises to be of the pleasant | | | | True, by buying and selling that is clever or lucky, |
| variety. So, I’m going to start by chucking the | | | | investor A may take more than his share of the pie |
| idea of Google being an extraordinary business. For | | | | at the expense of investor B. And, yes, all investors |
| now, let’s just call it average. | | | | feel richer when stocks soar. But an owner can exit |
| Who would want stock options in an average | | | | only by having someone take his place. If one |
| business? Let’s pretend no one would. Since | | | | investor sells high, another must buy high. For owners |
| there's no downside, I think everyone would; but, | | | | as a whole, there is simply no magic — no |
| let’s just ignore that inconvenient fact. | | | | shower of money from outer space — that |
| We’re going to pretend Google won’t | | | | will enable them to extract wealth from their |
| be diluting its shares at all. For the next fifty years, | | | | companies beyond that created by the companies |
| there will be no new shares and no stock splits. | | | | themselves. |
| As a public company, Google has earned an above | | | | It is now obvious I picked Google just to get your |
| average return on equity. It hasn’t been an | | | | attention. Google may very well earn a return on |
| earth shattering return on equity (it’s no | | | | equity much greater than 12% for the next fifty |
| Timberland), but it’s been better than most. | | | | years. It has already earned extraordinary |
| Of course, with Google, you’re not paying up | | | | profits. |
| for the current return on equity — | | | | Even if it does grow at a phenomenal rate, it will, |
| you’re paying up for all the ridiculously | | | | during the next half century, likely shed excess |
| profitable growth to come. I’m willing to meet | | | | equity by paying dividends, buying back stock, or |
| the Google bulls halfway on this one. I’ll give | | | | transforming itself into a holding company. I |
| you growth, but no unusual profitability. You’re | | | | don’t see a way the company could possibly |
| going to get a 12% return on equity, but there will | | | | put more than $2.5 trillion in equity to good use in |
| be no limit to your growth. | | | | search and related businesses. |