Written by Gennaro Gallo, ex-Google and ex-Oracle editing from Los Angeles.
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87% percent of Google’s revenue comes from advertising. Facebook, 97%.
Every company is worth more than it makes in one year. In the stock market, they boil this idea down to a P/E ratio (stock price-to-earnings ratio). The logic here is that a buyer would be willing to pay more for a company than it made in a year because it will probably make that much money again the next year. And it might make even more next year.
Multiples are extraordinarily important to a company. The higher their P/E ratio, the more a company’s stock is worth. That stock is money — money they can use to buy other companies. A high P/E ratio makes a company more expensive, insulating it against hostile acquirers. And at present, there are very few companies that could even contemplate buying Google or Facebook. In fact, there is only one — Apple.
Looking at the PE ratios for these companies, as of today, we see:
- Google: 36.49
- Facebook: 37.74
Google and Facebook’s ratios are even higher than other tech companies. Apple’s is 17.86, Microsoft’s is 28.61. Some are higher — much higher. Amazon’s is 253.06.
Facebook and Google have won the war on direct advertising, but are losing the war on the much larger, more profitable, and TV-intensive brand advertising. Their growth potential is severely limited. Also, the entire ad industry is capped annually just under $600 billion total. That number only goes up with GDP growth, and GDP growth… no way!
Google and Facebook have zero cost advantages when it comes to capturing the remaining ad dollars. And they don’t even have that much money to play this war of attrition/brand/TV content. Google has $92 billion, Facebook, $30 ish. Apple, by contrast, has $256 billion in the bank.
For a comparative example, Disney has $12 billion or so, but this is a different number because when you come down to it, the amount of money these tech companies are planning on spending on content is minuscule compared to Disney. Disney’s cash on hand is a different beast because it already spends astronomically more money on content than any of these tech companies are contemplating.
In short, based on projections I see no reason that Google or Facebook deserves its P/E ratio. It has zero advantages in the one big growth area it can realistically go after, the brand budgets currently spent on TV.
Furthermore, that market is not a growth market. At best, if and when it migrates to digital, it will be the same size, and Google will have no advantages. At worst, the migration to digital, along with massive competition decimates ad rates. And that’s probably why Amazon is getting a P/E ratio of 253.06, it’s essentially another vertical. 🙂
*Extracts from RWebb. The guy is dope.