WallStrip is touring the Google campus today. I just opened a position in GOOG a few days ago and have some more money slated to invest in it if the price drops from here or breaks up from here (and forces a MA crossover). Christian asks why I feel the need to invest in GOOG. The simple answer is that I think the price is going to go up… a lot.

People are scared off by the \$500 price tag, but GOOG is actually a value play by my calculations. Let’s try this. E*Trade has GOOG’s 2006 EPS at \$10.58. So what would GOOG’s EPS growth rate and average PE need to be to warrant a sticker price of \$515? The answer is a 20% growth rate and average PE of 30. Here’s the math:

Starting EPS: \$10.58
EPS Growth: 20%
EPS in 10 Years: \$65.51 (This is simply calculated by compounding our starting EPS by 20% for 10 years)
Average PE: 32 (Or more specifically what we can expect the PE to be in 10 years.)
Future Value: \$3,078.90 (Simply the future EPS x the future PE)
Sticker Price: \$524.07 (In order to make a 15% per year return on my investment in GOOG, I’d have to buy at this price.)

So if you think Google will have 20% EPS growth and a future PE around 32, GOOG would look fairly priced to you. However, GOOG is going to grow much faster. And if history is an indicator it will have a much higher PE. How fast? How high?

E*Trade has the past 3 years EPS for GOOG at \$10.58, \$5.70, and \$2.73 respectively. That’s an increase of 80% from 2005 to 2006 and an increase of 110% from 2004 to 2005. So GOOG is already growing much faster than 20%. Can it grow as much as 30% on average year-over-year for the next 10 years. I think so.

What about PE. The historic PE is somewhere between 60 and 250. Two times growth (a typical rule of thumb) would be 60. Let’s be conservative and say it will still be 30 and do our calculations again.

Starting EPS: \$10.58
EPS Growth: 30%
EPS in 10 Years: \$145.85
Average PE: 30
Future Value: \$4375.63
Sticker Price: \$1093.91

And if we wanted to do like Warren Buffet and buy \$1 for \$0.50, we’d only buy GOOG when it had a 50% Margin of Safety (MOS)… which would be at \$546.95.

So if you expect GOOG to grow at 30% over the next 10 years and you think it could warrant a 30 PE in 10 years, you would be loading up on this guy at the fire sale price of \$514… well below a comfortable MOS price. Ride it up to \$1093 and double your money.

Before I end, I want to do one more calculation. A lot of times we talk about EPS and EPS growth rates, but don’t stop to think about what that really means for the company. The more typical question is “can GOOG sustain 30% growth year-over-year”? Let’s take a look at GOOG’s actual earnings (in dollars) and see what it would mean if they went up 1400% (EPS of \$10.58 to \$145.85).

Right now there are 312M shares of GOOG out there. So with EPS of \$10.58, that gives us earnings of about \$3.5 Billion. Now if we multiply that by 14, we’ll get what our growth rate puts GOOG earnings at in 10 years: \$49 Billion dollars. That’s \$49 Billion dollars per year… earnings. Exxon just made record earnings \$36 Billion last year. So GOOG would have to trounce that.

I’ll leave this explanation for a future post. I need to gather my research, which will focus on the amount of advertising spending worldwide, how much of it is online, how fast it’s growing, how fast Google’s share is growing. Feel free to comment on it now.