Dr. P.V. Viswanath



Economics/Finance on the Web
Student Interest


Moving the Market -- Tracking the Numbers / Quite Contrary: Analyst Takes Contrarian Google View
Karen Richardson, Wall Street Journal, Oct. 28, 2005, pg. C.3


A FEW DAYS after Google Inc. announced strong third-quarter earnings last week, most Wall Street analysts rushed out new price targets for the stock -- some as high as $450. They concluded that shares of the Internet search engine, which have quadrupled since going public last year, were a bargain at more than $300.

But Eugene Walton of Walton Holdings LLC in New York reiterated his "sell" rating, although he raised his 12-month price target to $225 from $200. The mean of 22 analysts' price targets surveyed by Reuters Estimates, meanwhile, was $384.55. Google shares closed yesterday down $2.38, or 0.7%, at $353.06 in 4 p.m. Nasdaq Stock Market composite trading.

Mr. Walton runs a one-man independent research firm out of his apartment on Manhattan's Upper West Side. He set up shop after the big 2003 settlement with regulators that required some of the largest Wall Street brokerage firms to offer independent research to their clients alongside their in-house reports.

The 46-year-old Mr. Walton, who earned a master's degree in 1986 from the University of Pennsylvania's Wharton School, uses the discounted-cash-flow method to value companies. In the world of Internet stocks in particular, many Wall Street analysts use the "relative value" method.

Discounted cash flow requires analysts to use estimates of future cash flows and long-term growth rates in their calculations. Most tech analysts use what is known as relative value, which rates companies compared with their peers, and can justify higher share prices if an industry as a whole is overvalued. Some say the relative-value method helped feed the Internet-stock bubble of the late 1990s, which popped when it became clear that high valuations couldn't be justified by companies' revenue and actual profits.

Mr. Walton's "sell" rating would seem to be a risky call. The Mountain View, Calif., firm continued its streak of stronger-than- expected quarterly performance, nearly doubling third-quarter revenue to $1.6 billion. Profit surged sevenfold from the year earlier to $381 million.

Having a contrarian outlook isn't easy, and Mr. Walton is one of many analysts who struck out on their own after the big research settlement, only to find themselves part of a research glut, with hundreds of cheap or free research reports in circulation. His business isn't profitable and most institutional investors have ignored him, Mr. Walton says, despite his efforts to market his work.

Many of Mr. Walton's Wall Street peers expressed some reservations about Google's future growth rate but still upgraded the stock, saying they believe the company will outperform the competition. Uncertainty about Google's future warrants use of more-conservative assumptions, Mr. Walton says. In his valuation, he assumes that Google's long-term, or "terminal" growth rate -- the rate at which cash flows are expected to grow, theoretically, in perpetuity -- is 2%. Another analyst who uses discounted cash flow, Philip Remek at Guzman & Co. in Coral Gables, Fla., used a 7% rate to come up with a price target of $260.

The relative-value proponents "want to play it both ways," Mr. Walton says. "They're being conservative about earnings beyond 2006, but they're also trying to justify the current share price. You can't do that."

Many academics contend that terminal growth rates should never be higher than the gross domestic product; otherwise, a company would eventually grow so fast that it would overtake the entire economy. Goldman Sachs estimates the GDP growth rate over time at between 3% and 3.5%.

Aswath Damodaran, a professor at New York University's Stern School of Business who specializes in valuation, says he isn't surprised that analysts using the relative-value method find Google to be fairly priced or undervalued. They feed into their long-term growth assumptions "whatever irrationality is driving the stock price today," he says.

Mr. Walton believes Google's longer-term prospects could be dimmed by competition. As Google improves its search-engine technology, he says, users might feel less need to click on nearby ads to get more information, which could hit a key source of Google's revenues.

He also is bearish on other Internet stocks, although his ratings are more in line with his peers than they are on Google, according to data submitted to Thomson Financial.

Timing has worked against him before. In the late 1990s, during the Asian financial crisis, he was hunting down stocks in Indonesia and Thailand for Millgate Capital LLC, a New York hedge fund co-founded in 1997 by James Lyle, a former managing director of Tiger Management LLC. "Some of the work he did with us was better than what we saw" from brokerage firms, says a former colleague at Millgate.

Mr. Walton, who had a strong interest in the technology sector, left Millgate in 1999, hoping to set up his own fund. The tech-stock downdraft that began in 2000 put him off to a poor start, and he turned to research in 2003. Now, he concedes it might be time for another career change.



  1. How would you come up with a terminal growth rate? What factors would it depend upon?
  2. Do you think the relative value method is more appropriate in the context of the article?
  3. Why do you think many analysts preferred to use the relative valuation method?