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This exercise presents a stepbystep example of how to use Whitebox Research to calculate the Price Implied Expectations (PIE) for Google. We will demonstrate how to estimate what we believe the financial operating variables are that determine and justify Google’s stock price today and then demonstrate how to use the model to explore how different assumptions about those variables can change the PIE relative to Google’s stock price.
Looking at the PIE calculator module we have to enter a series of variables in order to calculate PIE:
 Percentage yearoveryear sales growth. The percentage year over year growth in future sales: Based on analysis we expect GOOG sales to grow at 18% per year for the foreseeable future.
 Starting sales. Sales for the last four quarters (in millions of dollars). As of the end of September 2006, GOOG’s trailing twelve month revenue was $8,207 (in millions, this is $8.2 billion).
 Operating profit margin. This is what you think the future operating profit as a percent of sales will be for GOOG. Start by looking at what it is today (29% as of the last quarter) and then think about what it would or could be in the future. We’re assuming that this will be 21% as future offerings for GOOG are not as high margin as search is today for the company.

Incremental fixed capital investment rate is equal to how much incremental fixed capital the company must invest to generate a dollar of new sales. For GOOG we took the average of the change in capital expenditures less depreciation and amortization divided by the change in sales for the last four years. For GOOG we estimate that this is 34%
 Working capital investment rate equals cash tied up by a company's short term operating assets, netted against short term operating liabilities. It tells us how much cash the company typically ties up in
working capital to generate a dollar of new sales. For GOOG this is the average of the change in working capital in each year for the last 4 years divided by the change in sales over 4 years or 6%.
 The cash tax rate is the percent of pretax operating profits a company would pay in cash taxes assuming it was 100% equity financed. For GOOG this is their tax rate from the last quarter, which was 31%.
 Since GOOG has no debt, the Weighted Average Cost of Capital (WACC) for GOOG is calculated using the Capital Asset Pricing Model which is: Cost of Equity Capital = RiskFree Rate + (Beta times Market Risk Premium). In GOOG’s case we calculated this formula as 4.88% +(1*3.2%) wich equals 8.08%.
 We get the inflation rate from the latest 10 year treasury which was 3.8%.
 Share Price is yesterday’s closing price: GOOG $429.00.
 Shares Outstanding is last quarter’s weighted average number of shares outstanding in millions. For GOOG it was: 310.4
 Debt is the long term debt on the balance sheet at the end of the last quarter. For GOOG this is 0.
 The capitalized the value of future Operating Lease (in millions) is a little tricky as this information is pretty buried in the notes to the financial statements. In most cases, in our experience, it is not going to materially change the calculation, however when we calculated it came out to about $75 million for GOOG.
 Employee Stock Option liability: The outstanding granted and expected future option "cost" (in millions). See www.expectationsinvesting.com for a detailed explanation. Again, this variable is a little tricky, but for a growth oriented company with a lot of stock options it can potentially have a large impact. For GOOG we estimate that this number is about $4,000 ($4 billion).
 Cash and Marketable Securities for GOOG are found on the balance sheet as of the last quarter and represented $9,822 (or $9.8 billion).
We then click on calculate and the Price Implied Expectation is calculated at $437.46 which is pretty close to the current price of GOOG when we did this analysis.
The fun can now begin as we test these assumptions and see where GOOG can go, either up or down, based on how GOOG’s business changes and, in turn, how these variables may change. For example let’s say that we believe GOOG operating profit margin will stay at 29%. What does this mean for the implied price? Well if we go back to the PIE calculator and use the same variables as we just did but enter 29% instead of 21% for operating profit margin, the PIE comes out at $668.29. So if we really believe that there is opportunity for the operating margin to be that high, and we think the market doesn’t realized or appreciate that fact, the stock may be undervalued and could appreciate if the market realizes there is upside in GOOG’s operating margin resulting from underlying changes in its operations…for example higher margin service offerings.
Remember this model is just that, a model and it is only as good as the thinking that goes into it. While some of the financial variables will be “hard”, others will be left open to your thought process, assumptions and justifications. The variance that comes from this is encouraged as it will make the model richer.
Click on the link for more information and tutorials on calculating PIE: www.expectationsinvesting.com.
Click to order the book: "Expectations Investing"

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