The management and Directors of Google have stated that there is no plan for Goo
ID: 402125 • Letter: T
Question
The management and Directors of Google have stated that there is no plan for Google to ever pay dividends. Yet, the stock trades at a very high price in dollar terms (around $490 per share currently) and at a P/E of around 20.
Based on the valuation concepts discussed in the text, how can these values be justified by investors (investors must have done that because they are the value placed on Google shares by folks actually buying and selling the shares)?
How accurate can that justification be? What factors are likely cause errors in valuing Google stock?
Explanation / Answer
In this case the valuation is based on the company's growth potential. If you believe in a strong-form market efficiency (share prices reflect all information, public and private) investors see that the company consistently meets or exceeds revenue and profit goals, allowing them to project the company's growth rate.
Because this growth rate is exceedingly high the investors don't need Google to issue a dividend, and it would actually be a better use of cash for the company to invest in itself as it can further increase growth and service offerings.
The justification is subject to the mercy of the market, however investors do have the ability to see the trends in the company's financials, which (once again if you subscribe to semistrong or strong market efficiency) is how the valuation is based. It is justified on historical and statistical information. (although I do not know what valuation topics you have discussed in the text, and this is my own meandering thought).
Mis-judgements in these trends as well as "black swan" extraneous factors (anti-trust suit, new competitors, or other threats) could negatively impact growth and the stocks value.
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