The Deipnosophist

Where the science of investing becomes an art of living

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

18 July 2010

Google/GOOG: Predator or Prey?

This blog began 5 1/2 years ago amid my oft-repeated recommendations to invest in Google/GOOG... but even before those recommendations were my private entreaties elsewhere. Google went public in August of 2004, but investing in its shares at that time was neither layup nor a popular decision: The PLAYBOY interview with the company's co-founders published mere days in advance of the company's IPO angered the SEC for violating a few rules and the company's unusual IPO did not ingratiate the company with powerful Wall Street interests. Many people feared the shares would founder, if not sink, post-IPO.

But a good story never keeps a good stock down for long. And Google had a good story. They kept it quiet, hidden, enshrouded in secrecy and whispers for as long as they could but the IPO busted open just how profitable the company was. And because the company took another non-traditional step of no quarterly guidance to Wall Street, the combination proved profound: secrecy + powerful revenues growth = surprising earnings gains. The stock rose accordingly.

A few people questioned the company's torrid growth, centered on whether Google was and would remain a one trick pony. (Its one trick being search.) In the quest to increase and diversify its revenue stream, the company bought many other companies, both large and small, integrated those purchases sometimes well but more often poorly if at all, offered many new products to its users -- so many new products to so many users, in fact, that its product line became unwieldy with diffusion. (I have registered my own complaints; Google's products that I deem core to my life have become near intolerable with their unreliability to the point that I almost no longer use them.)

Google definitely suffers growth pains -- although most companies would love to suffer growth pains even remotely similar. At some point, though, Google must begin to monetize the many strands of spaghetti they have flung at the wall, and not rely on their one stupendous cash cow, search. Perhaps its new great success will be the Android operating system for mobile, which became a rapid and surprising success. Perhaps Google finally will calculate a method to capitalize on its massive purchase of YouTube. Or DoubleClick. Or AdMob. (This list of purchases could really lengthen the page, so I will stop here.) Not to neglect the home-grown opportunities: GMail, which was so startlingly fantastic when revealed, and now the company allows to whither on the vine. And so on.

Google's revenues have finally decelerated from their torrid pace of growth, as the critics argued, if for no better reason than the Law of Large Numbers, but the company's earnings now pay the price for lazy management, negative growth YoY, as reported last week. Such an event is a cardinal no-no for a growth company; it calls into question your nature as a growth company. Part of the problem at Google, I suspect, is management's utter trust that revenues and earnings would continue to out-pace CapEx and SGA into the knowable, and unknowable future. A difference exists between budgeting and hewing to a budget and spending willy-nilly with the expectation that a revenue stream will continue ad infinitum. Of course, I am not privy to executive level discussions at Google -- it is possible they have another trick up their sleeve.

I have been thinking about this all for the past few years, but it all came to a head this weekend when I read this brief report by Eric Savitz...
THE OTHER BIG EARNINGS REPORT last week came from Google. It modestly beat Street expectations at the top line, but missed by a few pennies at the bottom line, as expenses exceeded Street expectations—reflecting in part the fact that the company is bulking up again, adding nearly 1,200 people in the June quarter alone.

While Google (GOOG) has struggled to generate significant revenue outside the mainstream search-ad market, it nonetheless grew revenue 24% in the latest quarter, while ratcheting up its cash position to $30 billion. Google trades for 17 times expected 2010 profits, and 15 times 2011 estimates.

No question, there are tough issues for Google, but it remains one of the best plays on the continued growth of Web content and commerce. Concerns seem well-reflected in the stock; through Thursday, Google was down about 20% this year. For buy-and-holders, this looks like a nice entry point.
The crucial misunderstanding, and one shared widely, is Savitz's penultimate sentence in his final paragraph, "Concerns seem well-reflected in the stock; through Thursday, Google was down about 20% this year." My problem is
1) Friday's wild down day changed the calculation to 25% down for the year from 20% in one fell swoop, which effectively demolishes Savitz's argument that the "concerns are well reflected in the stock." Oops.

Also, and more important, is the notion that
2) Because a stock is lower since some artificial date (in this instance, 1 January), everything is somehow okay for investors to take the leap, and invest. But this confuses cause with effect; effect with cause.

Investing is rarely, if ever, a static endeavor; more typically, it is a dynamic process. Imagine the arcade game with the ducks moving by from left to right but now, they also move up to down, diagonally, and always randomly. And, who knows, perhaps you might move as well. It becomes more difficult to settle the cross-hairs on such a moving target, no? Welcome to the world of investing. Eric Savitz's perspective is... well, quite one-dimensional, though instructional.

You can see investors' indecision easily via the merest glance at Google's chart, especially its weekly basis (the better to capture all trading data since its IPO). An identifiable area pattern builds in that periodicity, a rather large area pattern that carries some measure of significance. A better, more valuable harbinger for investors might be obtained from incorporating such a birds-eye view, rather than one so artificially epochal as since 1 January.

This post continues on Investment Poetry.
-- David M Gordon / The Deipnosophist

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