Portfolio Report #1

Macroeconomic Analysis
According to U.S Bureau of Economic Analysis (2015), all vital macroeconomic indicators in
the first quarter of 2015 have deteriorated comparing with fourth quarter in 2014. The GDP figure
has declined by 0.4%, according to the Bureau, primarily due to reduced exports, declined nonresidential investments, and reduced government expenditure. Consumer price index fell by 1.8%,
although consumption has increased by 2.4%. Nevertheless, such slight improvement was still
paled by the last quarter in 20141.
Corporate profits also present a pessimistic picture. They have decreased compared with fourth
quarter in 2014, for current-in-production firms, financial institutions, and not-for-profit
corporations, while tax from corporations increased during this period. Dividends on the other
hand increased. Given the negative economic environment, this may imply vanishing investment
opportunities. The current M&A driven bull market may also help substantiate this notion.
In terms of R&D development, Robbins, Belay, Donahoe, and Lee (2013) argue that from 1998
and 2012, R&D input cost price index has increased by 1.2% compared with 2.4% of GDP growth
among American businesses2. Further, the authors assert that R&D accounts for 60% of GDP
growth factor and consequently, the R&D sector continues to show positive growth contribution.
The main contributing factor stems from the fact that R&D prices had been relatively stable over
the time horizon.

Industry Analysis
1

U.S Bureau of Economic Analysis. National Income and Product Accounts, Gross Domestic Product: First
Quarter 2015 (Second Estimate), Corporate Profits: First Quarter 2015 (Preliminary Estimate). U.S Bureau of
Economic Analysis. Retrieved from: http://www.bea.gov/newsreleases/national/gdp/2015/gdp1q15_2nd.htm
2
Robbins, Carol, et al. (2013). Industry-Level Output Price Indexes for R&D: An Input-cost Approach with R&D
Productivity Adjustment. U.S Bureau of Macroeconomic Analysis. Retrieved from:
http://www.bea.gov/papers/pdf/industry_level_output_price_indexes_for_r_and_d.pdf

The internet industry under technology sector is a relatively new industry with 1.2 trillion
market capitalization, consists of 392 listed companies. Compared with some of the giant
traditional industry such as oil & gas sector, the growth of market capitalization since 1990s has
been rapid. According to Boston Consulting Group model (an evaluation matrix with market share
and growth as variables), the internet industry presents both enormous opportunities as well as
risks. The internet industry is a fast growing industry with new game changers (e.g. consumerfriendly application) emerging on regular basis, which provides solid evidence to the very fact that
the industry relies heavily on capital investments. The cash-burning aspect of internet industry
according to the BCG model can be categorized into either problem child or star corporations.
In other words, internet firms are likely to be either a disaster or highly successful and lucrative 3.
While the internet industry used to be highly sensitive to business cycles (e.g. early 2000s), it has
become an integral part of North American lives, and the effect business cycles has diminished.
However, since the industry thrives on new utilities, the internet industry is a highly lucrative yet
volatile industry. R&D commitment is necessary for both start-ups and established firms.
Remarkably, R&D is very risky with unpredictable financial and time commitment 4. Luck
therefore plays a huge role and some successful giants now used to be tiny start-ups. This also
makes the industry a very attractive option for venture capital and private equity investments. In
addition, resulting achievements may not consist with consumer interests. Therefore, above all, the
major risks associated with internet industry dont come from external sources. More importantly,
rivalry among competitors within the same industry aiming towards similar goals is the principle
threat.
3

Wertheim, Richard M. (2006). Investment business Internet revolution: prospects and perils. Canadian Speeches
4: 24-55
4
Wertheim, Richard M. (2006). Investment business Internet revolution: prospects and perils. Canadian Speeches
4: 24-55

Company Analysis
Among four major equity valuation models, Dividend Discount model (DDM), Free Cash Flow
model (FCFF and FCFE models), and Residual value model are all derived from the Gorgon
Constant Growth model. In other words, all these three models predict that cash flow will become
constant at some point in the future. There is good reason to make this assumption, because the
value of equity should reflect claim on future earnings, whether comes in form of dividend or free
cash flows. However, the internet industry is an exception, characterized by unpredictable future
growth and revenue stream. With this in mind, the only feasible model would be the multiplier
model to evaluate shock value based on cross-sectional data:
Company

Price

Trailing
P/E

EPS

P/S

RPS

P/B

BVPS

Fair value
estimate5

GOOG6

532.11

25.15

21.16

5.43

100.06

3.4

158.72

779.42

YHOO

42.94

5.86

7.32

8.58

4.86

1.2

35.91

146.47

80.14

77.03

1.03

16.52

5.05

5.95

13.47

45.28

N/A

36.01

N/A

10.17

N/A

3.52

N/A

N/A

FB

Average
(Multiplier data)

It gives an appearance that both Google and Yahoo are remarkably unvalued, while Facebook is
considerably overvalued. The multiplier model is in theory appropriate, considering all firms
being compared have comparable market capitalization and applicable P/E. On the other hand, it is
also worthy to consider several aspects of this evaluation model. Firstly, it is important to notice
that although all three companies are categorized under the internet industry, whether they are
truly comparable remains questionable. Since Facebook is a social network engine instead of a
search engine based company, it may have inflated the estimate of remaining two firms. Secondly,

Fair value estimate is calculated by multiplying each per share statistic of individual stock to average multiple,
then averaging the resulting outcomes to generate an estimate based on equal weighted average. For example,
GOOG fair value estimate is calculated as follow: (36.01*21.16+10.17*100.06+3.52*158.72)/3=779.42
6
Yahoo Finance (2015). Google, Inc. Key Statistics. Retrieved from: http://finance.yahoo.com/q/ks?s=GOOG
7
Yahoo Finance (2015). Yahoo, Inc. Key Statistics. Retrieved from: http://finance.yahoo.com/q/ks?s=YHOO
8
Yahoo Finance (2015). Facebook, Inc. Key Statistics. Retrieved from: http://finance.yahoo.com/q/ks?s=FB

the number of firms being compared is not optimal. Conventionally speaking, at least five firms
would be compared to avoid sampling biases. Thirdly, it is also worthy to notice that the equal
weighted average assumption may not be valid.