By not splitting its stock, Google risks hurting itself and the internet sector.
This was the thunderous conclusion of research this week by the technology analyst Mark May at Needham & Co, who has become alarmed at the headlines surrounding the Google share price's surge through $600 – barely three years after they were floated at $85.
The search engine pioneer's latest quarterly results are due this evening and are attracting more than their usual amount of excitement and nervousness, not least among the analysts who now reckon the stock is headed for the next big milestone.
Mr May says Google should consider snipping its shares into 10, with new shares valued in the $60-$70 range. "Unfortunately, retail investors and the mass media are often confusing a high stock price with a high valuation," he told clients. "Some, and possibly many, are interpreting 'Google $700' as a sign that the internet bubble has returned. We believe this misperception is bad for Google shareholders and for the internet sector at large."
So far, Google's founders, Larry Page and Sergey Brin, and its chief executive Eric Schmidt, have shown little interest in splitting the stock, so it might be up to Wall Street to dispel the perception that the valuation is stretched.
For there is no doubt that Google's valuation is optimistic. The company is worth $195bn. It is trading on about 40 times this year's likely earnings per share and that multiple falls to a still-high 30 times next year. The company is valued at nine times next year's revenues.
By way of contrast, technology bellwether IBM, a company that will bring in twice as much profit as Google this year, is worth less than $160bn. It is valued on a price-earnings multiple of 15 and a price-to-sales ratio of 1.6 times for 2008.
But of course, IBM is a mature business with lower profit margins and growing at a much slower rate than soaraway Google, which 10 years ago was not even a business, just a PhD project at Stanford University. Relative to their forecast growth, the p/e ratios of IBM and Google are both about the same, a perfectly average one times their predicted growth.
These are technical valuation issues – and that is the point. Google is a real business with real multi-billion dollar income. Analysts can debate the assumptions behind their forecast numbers and the likely trajectory of growth over the next few years, but what they don't have to do is conjure up some sort of mystical "new paradigm" of the way business will work on the internet.
Google makes its money selling adverts alongside search results on its own and on other people's websites, and in the third quarter it raked in about $3bn of revenue, more than 60 per cent up on last year – but analysts will be searching for clues on how that growth might slow. Google has plenty of questions to answer.
For example, will more or fewer people come to Google to search the internet in the future? (At the moment it is winning market share from rivals, but Ask.com for one is advertising heavily.)
Will Google's $3.1bn acquisition of DoubleClick, a technology business that helps plan online advertising campaigns, ensure Google dominates banner and video advertising in the same way it dominates search-based ads, in the face of heavy investment by traditional ad agencies?
And will advertisers pay more or less for their ads in future? (About 5 per cent of marketing budgets go on internet campaigns, compared to 15 per cent of consumers' leisure time spent on the net.)
These seem mundane investment questions relative to the wild assumptions discussed to justify dotcom boom valuations of companies with no discernible profits at all at the start of the decade. Some tech companies are much more airily valued than Google (its Chinese rival Baidu.com is on earnings multiples three times as high, for example, and don't even ask about the valuations being bandied about for Facebook), but there is not a single sell recommendation on Google stock on Wall Street.