Should you Invest in Amazon, Google, or Facebook?

By Krishna Maheshwari - May 31, 2012 | Tickers: AMZN, EBAY, FB, GOOG, MSFT | 0 Comments

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Amazon (NASDAQ: AMZN), Google (NASDAQ: GOOG), and Facebook (NASDAQ: FB) have all changed the world since their founding.  They are all growing at amazing rates and in all likelihood have significant growth ahead of them.  However, if you could only invest in one of these three companies, which one should you choose?

Let's consider a few key factors about these companies and compare them. 

(from Yahoo Finance on 5/25)

All three companies are fast-growing tech companies with loyal followers, outstanding records, and great growth prospects.  Each of them are led by their visionary founders. 

Facebook and Amazon have similar market caps and similar growth rates.  However, Amazon has much smaller margins than Facebook.  Google, on the other hand, is not growing as fast as the others, but has better margins than both.

Given that all three companies have had these high rates of growth for the last few years and could conceivably continue to grow at these rates for eight to 10 years, what would these companies look like in 2017?

The way we get to a projected market cap is to make an assumption about investors' willingness to pay for these companies (ie, the P/E ratio).  The P/E ratio can be thought of as the value shareholders place on the earnings of a company as well as the confidence they have in the companies' future growth rates.  We get to the figures above by assuming that the P/E ratio stays constant for each.

If we were to test these assumptions, our output will vary greatly.  Since all three companies are relatively high growth, the P/E ratio can quickly shift depending on how these companies' growth prospects change.  In 2017, the P/E ratio will look at growth post-2017.  In other words, if the P/E ratios we see for these companies today were to remain constant in 2017, it would indicate that investors in 2017 would believe that the company had another eight to 10 years of additional growth at the same growth rates as they are seeing today.

If this were indeed the case, then Amazon will outperform both Google and Facebook.  On the other hand, if the growth rates were to change (and hence the P/E ratio), then the outcome would be very different. 

How sensitive are these companies to changes in P/E?  Both Amazon and Facebook would gain or lose $2B on their market cap for each P/E multiple increment.  Google, on the other hand, would gain or lose $24B on its market cap for each P/E multiple increment. 

Since Google's market capitalization is the most sensitive to its P/E multiple, we need to better understand its downside.  A comparable high-tech company with once high growth rates is Microsoft (NASDAQ: MSFT).  Microsoft trades at a 10.64 P/E multiple and has a year-over-year projected growth rate of 10%.  If in 2017, investors thought Google had become like Microsoft (cash generation engine, but relatively slow growth), the increase in its market cap. would be similar to Facebook's (132% for Google vs 139% for Facebook). If on the other hand, Google continued to have similar prospects as today, than it would outperform Facebook (as indicated in the table above).

The only way that Facebook could outperform Google would be if it could increase its earnings growth rate faster than 30% in 2017 and beyond. 

Between Amazon and Google, if Google's multiple expanded to 15, than it would outperform Amazon (186% vs 179%).  This is possible given that eBay (NASDAQ: EBAY) has a P/E multiple of 15 and a year-over-year growth rate of 10%. Amazon, on the other hand, does not have a lot of room for P/E multiple expansion.  It would either need to increase its growth rate beyond 30% in 2017 or increase margins, which is something Jeff Bezos has indicated little willingness to do. 

It is more likely that Amazon's P/E multiple will drop than Google's.  The only reason that investors have such high confidence in Amazon's growth rate today is because it has managed to sustain such a 30% year-over-year growth rate over the past decade.  This confidence could quickly erode if Amazon were unable to maintain its growth rate.

Thus, the least risky company to invest in among these three would be Google's and would have the best upside potential over the next five years.

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