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onCampus--Ohio State's faculty/staff news

Vol. 38, No. 18


7-18-2007
By:

Ask an Expert, 7/19/07

Rudi Fahlenbrach is an assistant professor of finance in the Fisher College of Business. Have a question for an expert? E-mail questions to oncampus@osu.edu.

Google stock is swiftly approaching $600 per share. Obviously they don’t do splits, but is this still a bargain?
Financial economists argue that it’s very difficult to predict stock prices.

Current prices reflect all available information, and as such, investors can have confidence that if they were to buy a share of Google today, they would get a fair price. If Google was an obvious bargain, investors would buy the stock until it ceased to be a bargain. If Google was obviously overvalued, investors would sell the stock until its price was fair. A high stock price of $600 itself does not reveal anything about the attractiveness of a company, it only reflects that a company did not split its stock. Google’s large market capitalization (i.e., shares outstanding multiplied with the stock price) means that investors expect Google to continue to innovate and to grow more profitable in the future.

What price can Google’s stock reach?
There is technically no upper limit to Google’s stock price. Many firms have a preference to split their stock if the price exceeds $100. The main reason for this is that firms would like to remain attractive to smaller investors who like to trade in round lots of 100 shares. How does it work? Suppose you own two shares for $120 each. After a 2:1 stock split, you own four shares at $60 each, but your overall net worth has not changed — it remains $240. Warren Buffett’s Berkshire Hathaway Inc. class A stock has never split since the company was founded some 40 years ago. One share of class A common stock was worth $111,410 on July 6.

What are the basic determinations about what stocks make good picks?
Most finance professors I know hold well-diversified portfolios such as S&P 500 index mutual funds or exchange-traded funds. Stock picking is notoriously difficult, and we have overwhelming scientific evidence that on a risk-adjusted basis, individuals tend to lose money if they only select a few stocks to invest in.

Are you at all amazed at how well some Internet-based companies are doing?
During the 1999-2000 period, some small Internet companies without profits had a market value larger than that of General Motors, and the Internet was heralded as a technological revolution, similar to the creation of railroads or the industrial revolution. We have adjusted our expectations since, and a lot of Internet-based firms have failed. But it is not too surprising that some of the Internet-based firms that have persisted and have learned how to be profitable in the online world are reaping the benefits of a large market.


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