Google shares are a bubble waiting to pop
I agree (pretty much) with each statement - positive and negative - in the article below, except that... (see bottom of page)
Google shares are a bubble waiting to pop
Nils Pratley
Friday June 10, 2005
The Guardian
Who in their right mind would buy shares in a company at a price equivalent to 25 times its annual sales? For the past century of stock market investment, 25 times post-tax profits has been regarded as expensive. Here we're talking 25 times sales.
Think about it. Before a company converts any of its top-line income into bottom-line profit, it must fund the cost of its offices and staff, pay taxes and ensure it exists in a decade's time by investing in new products, some of which will inevitably fail. So a price of 25 times sales must be madness, right?
Not, apparently, in the case of Google. The search engine floated at $85-a-share last August but has behaved like a runaway train since. The price climbed 50% from late April alone and, at $285, the company is now worth more than $80bn (£44bn). But its revenues in 2004 amounted to just $3.2bn.
This year it might achieve $5.5bn, yet analysts at CSFB reckon $350 is a reasonable target for the shares and Smith Barney thinks $360, at which point Google would be worth more than the pleasingly round figure of $100bn.
Just seven years old, this week it overtook Time Warner as the world's most valuable media company. Or look at it this way: Google is worth more than the combined value of four of America's most established and successful media businesses: News Corporation, Clear Channel, Tribune and the Washington Post group. That quartet together would be a ridiculously dominant force across US television, radio and newspapers; they would never be allowed to combine.
Wall Street's love of Google seems to have two sources. First, revenues and profits are rising steeply, faster even than expected. Second, the business is clearly a creation of genius: an information processor that is at the heart of the most rapid changes in the way modern economies operate.
Its trick was to position itself as a way for corporate advertisers to reach potential consumers in a more precise manner than in the past - every little click on those highly targeted adverts earns money for the company. It's all done without employing expensive salesmen. Instead, Google holds an electronic auction to get the space next to, say, the words "car insurance". Low overheads mean operating margins run at about 40%. (Italics mine - dmg)
Impressive, certainly, but the game is young. Google has yet to prove it can sustain those margins, let alone keep revenues rising at a rate of 40%-plus a year, as Wall Street is expecting. In any industry, from metal-bashing to music publishing, a combination of high margins and booming sales attracts competition. Eventually, rates of return on capital settle down.
In Google's case, its share of online searches is already falling (although, to be fair, it is still more than 50%) and margins seem to be contracting (though, again, from high levels) - and all before the competition reacts properly.
Steve Ballmer, Microsoft's chief executive, has vowed that "we will catch up and we will surpass Google" - a serious threat when made by the world's biggest and most successful technology company.
Then there is Yahoo!, which is engaged in a bitter tit-for-tat battle with Google to create fresher and more innovative products and features. From the Google stable have come Google News, which aggregates news services; Froogle, a shopping search engine, and Local, a souped-up directory inquiries with maps.
Google's biggest launch will be Gmail, already available to a few thousand test users around the world. It is intended to be an email service that doubles as a storage facility for every aspect of the user's online life - the free memory space is so large that nothing need be deleted.
Test users, who are mostly tech enthusiasts, love the speed of the system but the rest of us may object to receiving subtle adverts personalised according to the contents of the files you choose to keep. Even if the Big Brother worries can be overcome, the key feature (the huge data storage) is hardly capable of being trademarked.
None of which is to deny Google's innovation and technical brilliance but, ultimately, it is a company selling a form of advertising space. Corporates are spending more of their advertising budgets on the web but there is a natural level of saturation and of return on capital. If the returns are excessive for too long, competition will arrive in droves. That is the way the world works and Google, as market leader but not a monopoly, is not exempt.
Yet the share price seems to imply the business can continue to grow at the current rate well into the next decade. Maybe it will stun us all and do so, but it is ridiculous to price the shares as if it had already been achieved.
It is bubble-like thinking that ignores the fact that companies rise and fall. Google did not exist eight years ago. Its conqueror may not be Microsoft but a start-up that nobody has yet heard of. Alternatively, old-media titans such as News Corporation and Clear Channel may find a way to claw back advertising revenues. A tougher stance on copyright would seem to be a fertile route.
During the dotcom madness, Sun Microsystems traded at $64, or 10 times its annual revenues. Anybody thinking of buying Google at 25 times should listen to Sun chief executive Scott McNealy's post-crash analysis of the stupidity of his own shareholders. In 2002, he said at an investor conference: "At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company.
"That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate.
"Now, having done that, would any of you like to buy my stock at $64? Do you realise how ridiculous those basic assumptions are? You don't need any transparency. You don't need any footnotes. What were you thinking?"
That same thinking, though, seems to be alive and kicking among Google investors.
... this rocket shot to a higher share price and valuation has yet to complete itself. That is, the share price will continue higher before reality makes itself known. Nonetheless, caveat emptor.
Google shares are a bubble waiting to pop
Nils Pratley
Friday June 10, 2005
The Guardian
Who in their right mind would buy shares in a company at a price equivalent to 25 times its annual sales? For the past century of stock market investment, 25 times post-tax profits has been regarded as expensive. Here we're talking 25 times sales.
Think about it. Before a company converts any of its top-line income into bottom-line profit, it must fund the cost of its offices and staff, pay taxes and ensure it exists in a decade's time by investing in new products, some of which will inevitably fail. So a price of 25 times sales must be madness, right?
Not, apparently, in the case of Google. The search engine floated at $85-a-share last August but has behaved like a runaway train since. The price climbed 50% from late April alone and, at $285, the company is now worth more than $80bn (£44bn). But its revenues in 2004 amounted to just $3.2bn.
This year it might achieve $5.5bn, yet analysts at CSFB reckon $350 is a reasonable target for the shares and Smith Barney thinks $360, at which point Google would be worth more than the pleasingly round figure of $100bn.
Just seven years old, this week it overtook Time Warner as the world's most valuable media company. Or look at it this way: Google is worth more than the combined value of four of America's most established and successful media businesses: News Corporation, Clear Channel, Tribune and the Washington Post group. That quartet together would be a ridiculously dominant force across US television, radio and newspapers; they would never be allowed to combine.
Wall Street's love of Google seems to have two sources. First, revenues and profits are rising steeply, faster even than expected. Second, the business is clearly a creation of genius: an information processor that is at the heart of the most rapid changes in the way modern economies operate.
Its trick was to position itself as a way for corporate advertisers to reach potential consumers in a more precise manner than in the past - every little click on those highly targeted adverts earns money for the company. It's all done without employing expensive salesmen. Instead, Google holds an electronic auction to get the space next to, say, the words "car insurance". Low overheads mean operating margins run at about 40%. (Italics mine - dmg)
Impressive, certainly, but the game is young. Google has yet to prove it can sustain those margins, let alone keep revenues rising at a rate of 40%-plus a year, as Wall Street is expecting. In any industry, from metal-bashing to music publishing, a combination of high margins and booming sales attracts competition. Eventually, rates of return on capital settle down.
In Google's case, its share of online searches is already falling (although, to be fair, it is still more than 50%) and margins seem to be contracting (though, again, from high levels) - and all before the competition reacts properly.
Steve Ballmer, Microsoft's chief executive, has vowed that "we will catch up and we will surpass Google" - a serious threat when made by the world's biggest and most successful technology company.
Then there is Yahoo!, which is engaged in a bitter tit-for-tat battle with Google to create fresher and more innovative products and features. From the Google stable have come Google News, which aggregates news services; Froogle, a shopping search engine, and Local, a souped-up directory inquiries with maps.
Google's biggest launch will be Gmail, already available to a few thousand test users around the world. It is intended to be an email service that doubles as a storage facility for every aspect of the user's online life - the free memory space is so large that nothing need be deleted.
Test users, who are mostly tech enthusiasts, love the speed of the system but the rest of us may object to receiving subtle adverts personalised according to the contents of the files you choose to keep. Even if the Big Brother worries can be overcome, the key feature (the huge data storage) is hardly capable of being trademarked.
None of which is to deny Google's innovation and technical brilliance but, ultimately, it is a company selling a form of advertising space. Corporates are spending more of their advertising budgets on the web but there is a natural level of saturation and of return on capital. If the returns are excessive for too long, competition will arrive in droves. That is the way the world works and Google, as market leader but not a monopoly, is not exempt.
Yet the share price seems to imply the business can continue to grow at the current rate well into the next decade. Maybe it will stun us all and do so, but it is ridiculous to price the shares as if it had already been achieved.
It is bubble-like thinking that ignores the fact that companies rise and fall. Google did not exist eight years ago. Its conqueror may not be Microsoft but a start-up that nobody has yet heard of. Alternatively, old-media titans such as News Corporation and Clear Channel may find a way to claw back advertising revenues. A tougher stance on copyright would seem to be a fertile route.
During the dotcom madness, Sun Microsystems traded at $64, or 10 times its annual revenues. Anybody thinking of buying Google at 25 times should listen to Sun chief executive Scott McNealy's post-crash analysis of the stupidity of his own shareholders. In 2002, he said at an investor conference: "At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company.
"That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate.
"Now, having done that, would any of you like to buy my stock at $64? Do you realise how ridiculous those basic assumptions are? You don't need any transparency. You don't need any footnotes. What were you thinking?"
That same thinking, though, seems to be alive and kicking among Google investors.
... this rocket shot to a higher share price and valuation has yet to complete itself. That is, the share price will continue higher before reality makes itself known. Nonetheless, caveat emptor.
posted by David M Gordon | 9:03 AM
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