Home > Economics - General > How much is Google worth?

How much is Google worth?

April 27th, 2004

According to this report, the widely-predicted Google IPO is likely to value the equity in Google at more than $20 billion – others suggest $25 billion. I immediately wondered whether Google was really worth $25 billion.

I started on a standard financial analysis. Although, as a private company, Google doesn’t have to publish annual reports, it’s been estimated that Google has annual revenues of $500 million and profits of $125 million so that the return on equity is about 0.5 per cent. We can expect that to grow reasonably fast in the next few years, but the scope for expansion in Google’s core business is far from limitless. Most people in the developed world are already online and most of the heavy users already use Google (Eszter Hargittai at CT might have more to say on this). Moreover, there’s no strong reason to suppose that Google will be around in, say, 20 years time. I find it hard to draw a plausible earnings path that would yield a present value of $25 billion at any reasonable discount rate.

That’s a problem for the investors, though. The Google example started me thinking about the more general problem of economic valuation in the Internet era. I started by looking at this piece by Simson Garfinkelhat tip – Tyler Cowen. As well as reporting potential competition from Akamai (relevant in considering Google’s longevity), Garfinkel estimates that Google operates a network of 100 000 servers, but that clever design allows the use of very cheap computers as servers. Let’s be generous though, and suppose an average of $500 a piece, allowing for costs of mounting and connection. This implies that the main piece of capital equipment operated by Google is worth around $50 million[1] – a hefty sum, but a tiny fraction of the estimated equity value (and presumably there’s some debt in there as well) .

Next, it’s of interest to look at capital-labour ratios. Google apparently has about 1000 employees, which would suggest a total labour cost of the order of $100 million per year – a little on the low side as a proportion of revenues of $500 million, but not implausible. On the other hand, the number of employees is minuscule in relation to the valuation above, which implies a capital stock of $25 million per worker. I feel sure that this kind of ratio would imply some pretty strange organizational policies.

Then there’s the question of how much Google is worth in economic terms. I would think the correct answer must be lot more than the present value of its revenues. I use Google all the time, but unless text ads have a subliminal effect for which Google is being paid, I’ve never contributed a penny to its revenues, and quite possibly never will.

The general problem is that, in an economy dominated by public goods, like that of the Internet, there’s no reason to expect any relationship between economic value and capacity to raise revenue. Things of immense social value (this blog, for example!) are given away because there’s no point doing anything else. On the other hand significant profits can be made by those who can find a suitable choke point, even if they haven’t actually contributed anything of value. Assuming for the moment that SCO prevails in its attempts to extract revenue from Linux users, it won’t be because SCO’s code was better than some free alternative but simply because it was widely distributed before anyone found out it was copyrighted.

If the Internet continues to grow in economic importance, the central role of public goods in its formation will pose big problems for capitalism, though not necessarily to the benefit of traditional forms of socialism.

fn1. I’ve corrected errors in this estimate – thanks to commentators Danny and Thijs at Crooked Timber

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  1. Dave Ricardo
    April 27th, 2004 at 19:27 | #1

    A lot of organisations pay Google big $ to provide the search engine for their sites. If Google becomes to searching what Microsoft is to software, then it might be worth $25 billion.

    Hard to see though how Google would lock in a monopoly on searching.

  2. April 27th, 2004 at 22:29 | #2

    I’m no economist and even less a venture capitalist, but isn’t it a rule of thumb that to value a blue-chip company you multiply their annual profit by 4?

    Even if we grant Google blue-chip status, which I’m not so sure, given the volatility of purely web driven businesses, then this equates to a valuation of $500M.

    OK, let’s grant them another 100% for the blue-sky of leveraging their client base (gMail, extra ad revenue etc) and you still only get $1 billion. A log way away from $25 billion.

    Even if you applied this ramp up factor to annual revenues, not profits, you will still only come up with a valuation of $4 billion.

    I could be wrong but my hunch is…

    Google execs reckon their nearing their maximum economic performance and see threats on the horizon, so it’s time to cash in with a float, dressed up with a few stunts (like gMail and an online float), levaing the mug punters to foot the bill when forecast perfomance isn’t achieved.

    Regards,
    Mark

  3. Andrew
    April 27th, 2004 at 22:48 | #3

    Sorry, but wasn’t gMail an April Fools joke. On the information page (at the very bottom) it has the legend “Happy Birthday April” and it was announced on that very day.

    Since I saw Emma Tom in the Oz write an entire column about the potential of gMail to undermine online privacy, and given Mark’s commment above, I’m starting to worry that I many have been too sceptical.

  4. Brian Bahnisch
    April 28th, 2004 at 00:32 | #4

    I think the google case shows why Warren Buffet stayed out of the tech boom, though at least they have a profit.

    Mark there are lots of ratios, but one of the commenest is the PE ratio, that is price (or market value) to earnings (net profit). The figure I keep in my head is 15 for Australian stocks, although it varies depending on sector, growth prospects etc,

    American companies have a typical PE of 25 or more, which used to mean that their growth was a lot better until recent years when it turned out not to be. The market correction which brought the Dow down to about 10,000 a few years ago should have gone further to about 6,000 imho, but then bad things may have happened for that reason alone.

    Btw don’t companies and presumably other organisations pay to have their stuff pop up at the head of the list?

  5. April 28th, 2004 at 04:38 | #5

    No – that’s one of Google’s selling points. Instead, you can pay to run your ad on the right hand side of the screen.

  6. Brian Bahnisch
    April 28th, 2004 at 07:22 | #6

    David, seconds before I wrote the line about companies paying I heard a news story about Axa taking Google to court in France because they’d paid to get noticed but all the other insurance companies were coming up as well. I don’t really understand it.

  7. April 28th, 2004 at 08:52 | #7

    I haven’t really looked at the financials.

    Gmail is a real service- they are offering it to bloggers up front if you still use blogger.

    Google’s real asset is the algorithm that it’s search engine uses. How much is that worth? Probably a couple of billion- $20 billion certainly is way over the top.

  8. Homer Paxton
    April 28th, 2004 at 12:02 | #8

    Google is clearly ahead for OXZ stuff but I find Wisenut as good for world wide material.

    The implied growth from the PE ratios is let us say on the high side. I am no courageous investor!

  9. Harry Clarke
    April 28th, 2004 at 12:04 | #9

    Professors Varian and Shapiro (“Information Rules’) saw the hype underlying internet stocks reflecting an intensely individually-visible technology. More visible than TV because one can ‘roam the world’ — hence the internet valued more than socially important developments in shipbuilding or materials science. This might be part of the reason Goggle is valued at more than any plausible present value. The Wall St hardnoses just get it wrong.

    But excluding such errors John’s point is a real puzzle. Why should a socially valuable technology with limited present value be marketable at a high price? Is it silly to suppose that, for some reason, the hard noses internalise the non-marketed value? If there is a sensible reason I can’t think of it. In a boom there might be ‘greater fools’ reasons but this is not so here.

  10. April 28th, 2004 at 12:30 | #10

    Worth every penny

    Try this very soon, before someone makes Google fix its site:

    1) Go to http://www.Google.com
    2) Type in “weapons of mass destruction” (DON’T hit return)
    3) Hit the “I’m feeling lucky” button, NOT the “Google search”
    4) Read the “error message” carefully. The WHOLE page.

  11. April 28th, 2004 at 12:57 | #11

    I thought the rule of thumb for valuing blue-chips was the “rule of 20″. Motley Fool has a succinct discussion of this which is worth abstracting (note this discussion is almost 10 years old and precedes the internet boom, had people taken its advice they would have missed out on a lot of dough):

    Another way to look at yields is to use the overly simple Rule of 20. The rule of 20 holds that the average P/E should be equal to 20 minus the current yield on 30-year Treasuries. This would suggest that the market may be a little ahead of itself now, but has some room to appreciate into next year.
    Fooldom has often heaped scorn upon what it calls the “solo P/E” method of valuing a stock. You know the type, “The P/E of XYZ Corp. is 24! I never pay more than 10 times earnings! Never!” The fallacy of this approach to valuation is revealed by examining its core conviction—that a dollar of earnings is worth the same whether it comes from a decaying steel mill or an expanding software house.
    Anyone who focuses on the quality of the fundamentals underlying a company can tell you that the stock’s multiple reflects the market’s expectations for growth, discounted by the market’s assessment of the risks involved in achieving that growth. The “solo P/E” approach completely throws aside the fundamental business in the same erroneous way that pure charting does.
    Don’t get us wrong, now; we have not gone “efficient market” on you here at the Evening News. We remain pretty skeptical of the “market’s” ability to estimate growth or discount risk; it consistently errs on the side of hysteria in either direction.
    The reason we bring up the “solo P/E” valuation system today is not to ridicule it some more or attempt to prove that you should never buy a stock unless it has a P/E of four. Rather, we would like to examine how one fundamental piece of information does affect the multiples of all stocks on the market—the interest rate on the 30-year Treasury bond.

  12. PK
    April 28th, 2004 at 18:15 | #12

    Google has something else that’s very valuable which many people overlook.

    It’s written an operating system which allows large numbers of cheap networked computers to become one big supercomputer including real-time back up storage etc. It is a self-repairing system – so if one cheap computer fails, others can take over its tasks until it is repaired. This makes it very cheap to maintain, as failing components don’t have to be replaced quickly.

    Most of its data is stored in memory across these linked computers and backed up in real time.

    What this translates to is that Google has what’s almost certainly the cheapest supercomputer on Earth, both in component and maintenance costs. It is cheaper than other comparable systems by quite a large factor (although I don’t know the exact amount, it’s a fraction of its nearest competitor).

    Currently, this supercomputer is running the search site, but it can run any number of other applications at a much lower cost than any competitors. The potential for new apps (such as Gmail) is quite large.

    This is the true value of Google and also one of the biggest sources of its competitive advantage. It’s unlikely that a competitor could replicate this for a long period.

    What’s this system worth? What’s the software that runs it worth? Good questions that are difficult to answer. But it makes the company a lot more valuable than most people think.

  13. PK
    April 28th, 2004 at 18:23 | #13

    If you’re interested in reading more about Google’s supercomputer here’s a link…

    http://blog.topix.net/archives/000016.html

  14. April 28th, 2004 at 23:06 | #14

    Someone suggested that Google is worth more than Amazon ($15billion?) since without Google eRetail would not be the same…How Much Moore? Ask any good ubereconomist!

  15. Brian Bahnisch
    April 28th, 2004 at 23:45 | #15

    PK the supercomputer sounds a good story and might justify the valuation. I would just caution that technological innovations don’t always translate into shareholder value.

    Jack with your amazing brain you don’t need a supercomputer. It’s a while since I did the introductory sharemarket lectures, but a PE ratio of 20 rings a bell, but I think it was minus the CPI rather than bond yields.

    The economist at ABN AMRO relates dividend yields to bond yields to value the whole market. The idea is that when share prices go up and yields go down investors shift to less risky investments like bonds.

  16. Harry Clarke
    May 7th, 2004 at 19:38 | #16

    BRW May 6-12 explains the high pricing of Goggle in terms of an emerging second internet bubble in the US. The National Venture Capital Association says 29 venture capital companies listed in the US in 2003 but this year numbers will be 93. ‘Silicon Valley is on course for another round of irrational exuberance’.

    If another bubble is on the cards then the ridiculous valuations of Goggle can be explained in terms of a ‘greater fools’ theory. If you believe this and buy then get out quick or if you are brave enough to believe the idiocy won’t outlive your interest costs, short it!

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