Please also keep in mind the date of this post.  Obviously over time, things change with financials for the better or for the worse.  This will just give a nice foundation, based on the writing date, of what I think the company is doing and what I, personally, would buy it at. This is NOT a recommendation to buy or sell the stock. 

When looking at any company, one of the most important things to determine is how liquid they are and if times got tough, would they be able to pay their bill? As you can see from the Current Assets image below, Google has grown its current assets each year from 2007 (I only went back to 2007).  They are showing liquidity and their current assets as a % of total assets is about 66%.  The one concern I always have with balance sheets is the long term assets and goodwill that a lot of companies will show on the books.  Those values can be determined by thorough evaluation of assets, but I prefer to focus on current assets due to the fact that they are hard to fake and overvalue.  

Now, one of the major factors of long term sustainable companies is their ability to pay their bills if times got tough suddenly. Let’s take a look at Google’s total liabilities and how it compares to total current assets.

This is the impressive thing for Google from a balance sheet perspective. They have almost 3 times more cash on hand, essentially, than ALL OF THEIR LIABILITIES COMBINED!! Unreal. This is a very good thing to see.  

Now, let’s take a look at revenue and profit since 2007.  

Consistent revenue and bottom line net income growth.  Net income has increased by 350% (2.5 times) since 2007 and they are the leaders in online advertising, which is their main source of business.  

This company is a prime example of a growth opportunity that has a lot of good years to go AND does well financially.  Now, just because the company is solid financially doesn’t make the stock price reasonable. On earnings of $10.75B last year and an average of a little over $9B over the past 3 years, the question is what multiple are you willing to pay. The brand is great…the innovation is still top notch.  With this kind of revenue growth and a stock market that, historically, values companies at 15 times earnings, a premium, I think, is due.  They are currently selling for 30 times earnings and for a company this mature, that is clearly, in my opinion, too much.  Have they done well since going public at a similar valuation? Sure. But like I always say, let them prove they are worth $300B before we give them that value. 

Their current price to book ratio is also a big aggressive at 4.5.  According to The Intelligent Investor, the P/E ratio multiplied by the Price/Book ratio should be less than 22.5. Currently, they are at 135.  Does that mean they need to drop by 84%?  Absolutely not! Remember, as the price goes down, it decreases the P/E AND the Price/Book value so you get an even larger drop in that Intelligent Investor ratio.  Now, do I think 22.5 is reasonable?  I think for a brand like Google, paying a premium is justified.  Innovation, mega profits, great cash flow, great brand, etc…Over the past 12 months, they have earned over $12Billion (2013 numbers are not officially done yet for the fourth quarter).  

I am interested in Google at around $600-$675 per share.  I know that sounds extreme, but the premium I am giving it is fair considering they are a service oriented business.  It still puts a nice premium on book value but doesn’t give away the farm and allows for some of their innovation to come to fruition and drive the bottom line. Remember, if we overpay for innovation and growth today, where will you be when that growth hits?  Even?  Or are you playing the greater fool theory of saying that someone else will pay you more because of growth? 

Microsoft was the most innovative company in the last 1990s and everyone paid through the nose for them.  Since then, Google, Facebook, and Apple have come to the forefront and made Microsoft a snoozer.  I own Microsoft because while everyone ignores them, I see value in great cash flow and earnings and revenue growth.  I think even if Google became the second player in the market, it will be a very good investment over time just by building up cash and making acquisitions and building their balance sheet. 

Remember, I am not a certified analyst. I am just saying where I would be a buyer of Google.  If a bear market hits soon, which I think it is likely, there will be some downward pressure on highly valued stocks. 

What everyone fails to realize is that crashes/corrections aren’t caused by things that can be seen. If they were seen, they probably wouldn’t cause the corrections.  The other thing to remember is that bear markets occur, not necessarily for reasons that are seen. They are just natural breaks in market surges. These things happen.  Is this happening now?  I don’t know.  What I do think, though, is that when we do have a cyclical market kick into gear, it will lead to a much more significant drop in equity prices than most believe is possible.  Everone still thinks that 30%+ drops are not likely even though we have had two 50%+ drops since 2000.  “Yeah, but that was a tech bubble and a real estate bubble. This time it’s different.”  Ha! What about the gov’t spending bubble?  Of course, no one will see it now, but when it’s all said and done, the same who didn’t see it will be proclaiming that it was so obvious that everyone saw it.  Again, if everyone saw it, equity prices wouldn’t have soared to the heights they are at today.

Overconfidence is a drug like no other.  It would be illegal if it were in pill form.  And it never changes.  It’s the same today as it was 10 years ago, 50 years ago, hundreds of years ago. Remember to assess everything from a historical perspective and don’t overwish something to occur because it makes you feel richer.  It’s nice to feel richer, but these are not real gains, unless you are cashing in today. In all likelihood, if you’ve stuck around this long, you probably haven’t read this far…you think I’m crazy. I’m fine with that. 

If history is any guide, we are going to have a bear market that will surprise many folks.  If you’re in it for the long run (20+ years), you will be fine.  Just buy ETFs along the way down and don’t believe it when people say, towards the end of the cyclical bear market, that the market will go down forever.  Yes, that’s exactly right…the same who are overly euphoric now will be overly pessimistic and negative when the cyclical bear is raging.  Be patient and remember that times are tough right now, but bad times don’t last forever.  It will happen.  It will be a great opportunity for those who have been patient and are willing to wait for better prices.  

Not much has changed in my outlook of the stock market and economy over the past 1 year.  And by that, I mean that the same troubles exist now that existed earlier, and if anything, the stock market has gone to levels even I didn’t think were going to happen during this cyclical bull market.  Of course, we can all be wrong at any time, and I have been devastatingly wrong.  That may be a harsh word, but it’s true.  To see the market up 25%+ a mere five years after one of the biggest crashes and rebounds in history is truly unbelievable to me.  We learn something new everyday when it comes to human psychology, I suppose.

Talking to investors now is like talking to them during every mature bull market.  The thoughts of 10% declines are even viewed as “not likely” and the idea that 1-3% is viewed as a buying opportunity is borderline hilarious to me.

Don’t look site of what makes markets fundamentally strong.  It’s not just supply and demand.  In fact, it’s never that.  The PERCEPTION may be that they are fundamentally strong when demand is high or supply is low, but that is merely perception.  What’s important is to understand what is behind the numbers.  Just because you aren’t coughing doesn’t mean that when you smoke a cigarette, you aren’t increasing your chance of lung cancer down the road.  The short term experience can’t be assumed forever.  

A lot of my readers work out and eat well for a reason…they want to be fundamentally healthy so they can live long and productive lives.  Why would the same not be the case for markets?  Why don’t we want to see good companies selling at good prices?  Well, it’s simple…we aren’t used to seeing our net worth decrease and equate that to an opportunity to buy good assets at much better prices. So many people claim to be long term oriented, yet think like a balance sheet: A snapshot of what is happening TODAY.  

When you buy an investment, don’t just buy it like it’s a baseball card that hopefully will go up in value.  Realize that it is a business that generates income and has future potential to increase that income and pay back its shareholders.  It takes a certain discipline, I give you that, as I see the VAST majority of “wealth managers” who don’t understand the basics of financial statements or how to evaluate companies and countless MBAs who use useless tools like WACC Analysis to determine a company’s financial strength . Just think “If I were buying this business as a whole, what would I pay for it?”  You would look at it as a stream of cash flow with potential for upside.

I’ve looked stupid for quite some time, and I am OK with that.  Let’s see how things go over the next 5-10 years.  As John Hussman always says, he evaluates himself after COMPLETE market cycles (A full cyclical bear and a full cyclical bull, or vice versa), not off the performance of just one.  Anyone can make money during a cyclical bull and anyone can lose money in a cyclical bear, but who can beat the market after they are both complete?

One cannot assume that the good earnings and the good returns in the stock market are not based on historical averages, yet people assume it does.  Why do people ignore history? Why is it that, for the last 143 years of stock market history, when people are most pessimistic, stocks go up soon after.  When people are most optimistic, stocks typically fall.  Is that coincidence?  Really?  Think about it…we’d all love to think it would be just coincidence, but it’s not.  When PE 10 is highest, the following 10 year returns are well below historical averages and vice versa when the PE 10 is lowest.  Yet, people love stocks when PE 10 is highest and hate them when PE 10 is lowest.  THINK ABOUT IT!

The one thing I found interesting is that people do extrapolate short term results almost to perpetuity. Look at what is happening now.  Long term interest rates are at all time HISTORICAL lows that have never been seen and everyone says that PEs on stocks should go up because of this.  Well what about when interest rates were at all-time highs back in the early 80s?  Did those rates stay up there forever?  No! So were those values on stocks reflective of the future? Absolutely not.  You CANNOT extrapolate short term results indefinitely into the future.  This is why HISTORY MATTERS SO MUCH! It is all relative.  How do fundamentals look now versus history? Have the things that have caused short term increases or falls look like they can last a longer period of time?  

Think about these things before buying an investment.  Look at history and see what it can teach you. As they say, it may not repeat itself, but it will rhyme.  

We are CURRENTLY at valuation levels that most secular BEAR markets start at and I see people calling this as a new secular bull.  This is insanity.  It actually gets my blood boiling to see these “experts” talk about secular this and that without looking at historical valuation metrics and realizing how high we are! This is completely insane.  

Beyond belief upset at this.  I know I shouldn’t be, but these are the same people you look to for advice and they are leading you into very rough territory.  Could I be wrong?  Yes. Of course I COULD be wrong, but I’m not.  

All past secular bulls have started when the 10 Year Cyclically Adjusted PE Ratio is in the single digits.  We are almost at 25 now!!! Every past secular bear (except 2000) has started when the 10 year PE is at 23…so we are at levels that most secular bears start! MAYBE we are at the tale end of the 1982 secular bull market.  But we are definitely not in a new secular bull.  

And the worst part is, when this all ends poorly in a few years with a large pull back (40%+), none of these people who were wrong will say “oops.  my bad.”  They will just keep pontificating to the lemmings  who listen to them.  

Base your investment decisions on fact and analysis…not on hopeful dreams and emotions.  

Insanity. 

The article above is quite interesting and relieving for a guy like me.  Last year, I started shorting Amazon and I have been killed so far. I am down TONS of money and I am holding out for the correction. It could become uglier before I am right…if ever.  Momentum and irrationality can take stocks to levels unheard of.  

In the article above, Musk (CEO of Tesla) and Hastings (CEO of NetFlix) warn of the values of their stocks.  REPEAT: THE CEO OF THESE TWO COMPANIES ARE WARNING ABOUT THEIR STOCK PRICES! And guess what?  Not many investors are listening. They are still driving up prices.  

This is a prime example of how stubborn momentum traders can be.  They aren’t investors.  This is also a sign, to me, of a bubble and the topping of the market.  When everyone thinks that things are going so well that even overinflated stocks can be driven higher after their CEOs warn about prices, you know things are of concern. 

Why?  Read on…

Lower interest rates, especially with rates being as low as they have been recently compared to history, have nowhere to go but up.  If you buy stocks or real estate because of the low cost of money, you are willing to pay a premium and pay more now because the interest charges are going to be lower, therefore profit higher.  But we all know what happens…when costs are lower, peopel are never going to continuet o pay the pre-low rate prices; they will be willing to pay more in order to be involved in the investment.

So when everyone talks about expanding multiples because of lower interest rate in stock market, what are you going to do when rates go back up and multiples have gone back to normal levels? You will take a hit to value which is a BIG hit to return.  Same with real estate.  If you are buying what would normally be an 8% cash return at 6% now because rates are 2% lower, what will happen to the value of your investment when rates go back up and you have to sell that same property at 8% again?  

This is based on the fact that rates won’t stay low forever.  Obviously.  You have to buy assets based on their LONG TERM value, not their short term potential profit.  Quite simple. 

As you can see, the blue line is the current market value of NonFinancial Corporate Equities Divided by GDP and the red line is the subsequent 10 year return on the S&P 500, nominally.  Obviously it isn’t exact, but as you can see, it is VERY close and should make everyone wonder.

If you see, right now, the ratio is at 1.2 and this says that over the next 10 years, based on this model, the S&P 500 will stay even or lose a little bit of value even after INCLUDING dividends.  Is this set in stone?  Absolutely not.  It has deviated both above and below this metric in the past.

Look at the late 1980s, the market ended up outperforming by several percentage points and in the mid to late 1960s, the market ended up underperforming what the ratio said it would do.  However, for the past, almost, 65 years, it has been pretty accurate.  You don’t have to have 20/20 vision to see that…

I know people think I’m negative nelly on my outlook, but the data remains to show that we are in very lofty valuations that can’t be sustained much longer.  

The interesting thing is that over the last 140 years, including dividends, the S&P 500 (or equivalent index) has returned 9.9%.  If you look at the crash in 2008 and 2009, we didn’t even hit the 10% 10 year estimated return.  I have told many people that I think fair value on the S&P 500 today is around the 800 mark which is a drastic drop from where we stand, but if you look at the massive crash from the peak of 1562 back in 2007 down to 666 in 2009, that may not be an unreasonable value.  

Stay tuned for the nominal return vs S&P 500 10 Year P/E Ratio.

Well, I was happy to see what happened this AM.  Microsoft annouced they would be taking a big chunk of their cash hoard to buy back their own shares to the tune of $40Billion.  Obviously, if a company is sitting on a lot of cash and they think their stock is undervalued, what better thing to do with their money than to buy their own shares.  This is a great sign that the people within the company have a lot of faith in their future and their prospects. 

Can they be wrong?  Absolutely.  But I would rather invest in a company that believes in itself and shows that with their money than a company, like Amazon, where no share buybacks are going and the main holders are constantly selling as well.

Again, they could be wrong, but they see the level of their stock and they realize they have potential to make some money on their own shares, so why not do that?  It’s a great indication of confidence and helps me feel even better about my decision to start buying shares.  

But everyone is missing something major here.  Stocks aren’t always based on company performance AND they are most certainly not to be used as a measuring stick when its measured against one of the most overvalued times in history.

In January 2000, Ballmer was named CEO of Microsoft after the founder, Bill Gates, stepped down.  The stock was selling at around $50 per share. It is now selling at almos $35 per share, for a 13.5 year drop of 30% before dividends.  So is this Ballmer’s fault?

OF COURSE NOT! At that time, Microsoft had a per share trailing twelve month net income of $0.71 per share for a price earnings ratio of over 70! Today, it has a trailing twelve month net income of $2.58 per share. That’s an increase of 263%, or 10.0% per year.  Not bad! If you were to take the same PE multiple back in 1999 (which is NOT a justification) and apply it today, Microsoft would be selling at $180 per share.  

My point here is that stock prices go up and down for many reasons.  Some stocks just become unsexy, as we saw with Microsoft over the past 13+ years.  The company is currently selling for about 12 times earnings which is insanely low, in my opinion, for such a diverse and steady company. Back in 1999, their sales were $19.75 Billion and now they are $77 Billion.  Current cash on hand, in 1999, was $21Billion and today it stands at $100Billion! 

Now, I am NOT saying that Ballmer is a great CEO. I don’t know enough about how things work there and what other competition has seen in that time, but this company has done well while watching Apple literally dominate everything in the computer world in the past 10 years as well as seeing Google dominate the search arena.  

Let’s keep in mind why stocks are selling at certain prices before we blame people.  It’s unfair to them adn it would be equally unfair to give him credit for the stock sky rocketing if he were starting at a time when the stock was priced below value, like today.