Monopoly Rules: How to Get the Next Big Thing to Market Ahead of Your Competition by Milind M. Lele

Author:Milind M. Lele
Language: eng
Format: mobi
Publisher: The Crown Publishing Group
Published: 2005-08-29T14:00:00+00:00

How does this compare to our drug company table? Google has the same MQ as Pfizer, 1.50. That suggests that if Google were a drug stock, it should probably have a P/S ratio in line with Pfizer’s, or around four times revenues. At that multiple, Google’s stock would be selling closer to $34 per share, rather than its current price of $177.

What if we make our projections for Google’s monopoly more generous? Even if Google’s sales double every year—in other words, if R = 1.0 rather than 0.5—Google’s MQ would be only 3.0. Consequently, its price-to-sales ratio, judging by the pharmaceutical industry comparison, would be only somewhat higher than Amgen’s—perhaps ten times revenues. That still means that Google’s stock should be more like $84 a share rather than $177.

Another way of looking at this question is to start with Google’s price-to-sales ratio and work backwards. By extrapolating from Amgen and Pfizer, we see that Google’s P/S ratio of 21 suggests a monopoly quotient around 6.0. This means that to justify its current price premium, Google should double its revenues every year and face no significant competition from Microsoft, Yahoo!, or anybody else for the next six years. Otherwise, Google stock is overpriced.

As this exercise illustrates, because of patents and the information required by FDA regulations, prescription drugs are the closest approximation on Wall Street to the ideal benchmark—a monopoly with revenues, profits, and monopoly period that are known in advance. Consequently, the P/S ratios for prescription drugs can be treated as a ceiling, an upper bound. For a given monopoly quotient, a rational investor shouldn’t be willing to pay more (that is, accept a higher P/S ratio) than for a prescription drug stock with the same MQ. In fact, if there’s any uncertainty about the company’s prospects, we should demand a discount from the prescription drug stock’s P/S ratio.

Time alone will tell whether Google is overpriced or will continue to grow as rapidly as investors apparently think it will. But our Google discussion shows the value of the monopoly quotient, MQ, in thinking about a company’s real market value (what value investors like Warren Buffett term its “intrinsic worth”). Calculating MQ forces us to ask some basic questions about the company: “What is the monopoly driving this company’s growth? How long will this monopoly last and why? How is Wall Street valuing its monopoly? Is this valuation reasonable?” We can then make up our own ideas about a particular stock and decide whether, at the current price, the stock is a sell or a buy.

Before you rush off and start picking stocks using MQ, a word of caution. First, remember that our pharmaceutical benchmark is quite rudimentary. The calculations we use have the advantage of simplicity; all you need to do is estimate the likely monopoly period and find out how fast the company’s sales have been growing. But our system doesn’t take into account the fact that drug companies are extremely profitable, while steel companies, car makers, and packaged goods makers (for example) are much less so.

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