As we’ve argued before, the “PE ratio” is the granddaddy of all yardsticks used to measure the stock market’s value. It measures the price of a stock for every dollar of annual earnings, or profits, per share of the company. A PE of 100 means that investors are willing to pay $100 for every dollar per share of profits made by a company.
Traditionally, a stock is considered fairly valued if its PE ratio is the same as the rate its earnings are growing. So a company with profits growing 100 percent a year would be fairly valued when its PE is 100. Right now, Google’s stock is trading at a PE of around 68 (taking a market cap of $56 billion and annual earnings run-rate of $816 million) but the company’s executives and other analysts point out, correctly, that it gets harder to grow as quickly when you’re a bigger company.
According to a recent AP story, David Garrity, an analyst Caris & Co., argues that a price target of $300 is reasonable for Google. That would give Google a PE of 100, meaning that Garrity is essentially predicting Google will continue to double its profit growth.
That is bullish. We wish Google all the best, but this analyst math is hard to square. The same AP story says analysts predict earnings will increase by more than 60 percent this year, excluding accounting charges for items like employee stock compensation. That’s not exactly doubling. So Garrity’s $300 sounds a bit high, no?
As the saying goes, this company is “priced to perfection,” in other words, only if it performs flawlessly will it hit $300, and even then it may not get there. As Janco Partners analyst Martin Pyykkonen tells AP: “There is virtually no margin for error.”