Musea, first, let me extend my thanks to establishing a forum in which reasoned discussion may replace rabid partisanship either for or against various internet related stocks. IMO, the most difficult stocks to evaluate are those of either e-tailers like AMZN, or those of the portals like AOL. I'd like to offer a possible framework for analysis in the context of any of these companies in a period of real or perceived hypergrowth.
I suggest that we start by making the simplifying assumption that the company in question has achieved maturity. The assumption of maturity is not intended to cap valuation or future growth, but to probe the cash flows required to achieve the stock's valuation. I have no idea what the valuation of AOL ought to be, but I might have a handle on that if I could see a trajectory from its current position to having sufficient cash flow to support its current market cap. That is in no way an attempt to intellectually constrain its growth, but rather, to at least generate a milepost along the way.
IMO, there is only one decent way to value an investment, and that is on the basis of discounted cash flow. For illustration, let's assume we have a black box that can generate cash at the rate of $1 per year at the end of each year in perpetuity. If we agree that the appropriate discount rate is 10%, then we would agree that the value of the box is $10. But suppose we could forgo this year's $1 dividend, and achieve a perpetuity of $1.50 beginning at the end of next year. Well, we would agree that a year from now the box would be worth $15, and thus $13.63 now (15/1.10). Suppose that the procedure could be replicated 10 times. Thus, ten years from now the box would throw off annual cash flows of $57.67, and it would be worth $576.65. But in today's dollars it would be worth $222.32 [1.5^10/(1.10^10)]. It would carry a forward-looking P/E of 222.32, which puts it right up there with companies like AOL.
All that I am trying to do is go through a similar exercise with AOL. Let's figure out what people see as the cash flow that will support today's valuation in the future, and then let's see whether those cash flow projections make any sense in the context of AOL's business model.
According to my calculations, AOL (currently selling at about $175) had an free cash flow of $.187 per share this quarter. If this were a mature "cash cow" like a utility, could we reasonably assume that the investors would require a multiple of cash flow at say 12x? In that case AOL would need to generate cash flow of about $14.60 per year to support the price, or $3.64 per quarter. That will require a growth in cash flow of 1,850% from now to whenever the company achieves that objective. The company would need to grow its cash flow for 26 consecutive quarters at 60% per annum to achieve that goal. And still, there would be no premium for shareholders, because effectively at least six and one half years of growth have been included in the current stock price.
In other words, if the stock were capable of growing its cash flow at 60% per annum for the next six and a half years, it could justify its current price six and one half years from now. So clearly, this analysis would indicate that investors expect that this stock will significantly outperform the scenario outlined above. They apparently expect the company to experience significantly higher growth rates for periods beyond the calculation.
Does this analytical framework make any sense? Am I missing something obvious here?
Thanks again for starting a thread with so much promise.
TTFN,
CTC |
