Google 2.0Posted on December 29th, 2005 6 comments
It seems to me that Google is in the news everywhere I look. In just the past few months, there have been not one, but two books written about Google. I’ve listened to both books and to summarize: two Stanford Ph.D. candidates worked together to create the world’s best search engine right around the time that everyone knew Search was dead and portals were going to be the source of all potential income on the Internet. They had no idea how to monetize the service, thinking, erroneously as it turned out, that they could license search technology. The Google search technology is the ‘secret sauce’ that makes Google better than every other search engine available. Eventually they found a business model by selling keyword targeted advertisements (Google Adwords and Adsense) and the rest is history. Now their stock is trading at a P/E of nearly 100 and the market cap of the fledging company is over $120B. A P/E rating of over 100 in itself isn’t alarming. For example, when a company is having a down year a P/E can get quite astronomical since when you divide a large market cap with a small earnings, you can get a very large number for the P/E. However, Google is insanely profitable making nearly 50% profit on sales of $5B so a P/E of 100 is truly staggering. In order to quell this embarrassingly high profit, Google appears to be speculating in the high tech market by purchasing really cool technologies whose only common theme is that none of them show any obvious way of making money.
Don’t get me wrong, I love Google. I use it as my home page. Making things like Blogger, Google Earth, Picasa, and Google Maps available for free without the ad spam usually associated with such services is extremely generous. But I can’t help feeling that their recent buying spree shows some similarities of teenagers with a pile of cash. You won’t find them investing in any blue chip stocks, but you can rest assured that all the latest high tech toys and cool technologies are under consideration. I could hardly believe it when I read that Google bought a Boeing 767. I’ve been a pilot and aircraft owner for 15 years and have some experience with the costs of owning and operating (admittedly small) aircraft. The costs associated with running a B767 for a few executives is in the stratosphere. If you contrast a B767 with a Gulfstream 5, today’s gold standard for bizjets, it will be many times the operating cost. Also, a B767 won’t get into smaller regional airports, which is one of the attractions of bizjets in the first place, i.e., to avoid the expense and inconvenience of international airports and to arrive closer to your target destination. The complete story on the Boeing 767 purchase has yet to be written, but it’s in stark contrast to the frugal practice of purchasing Google’s 175,000+ servers as parts and assembling them by hand, presumably to save money.
It’s really not Google’s fault the stock is trading so high. People fall in love with stocks of companies whose products they use all the time, and when that company happens to be profitable, then all reason can fly out the window. Just about all companies that come in contact with such windfalls have to do something with the money, before it evaporates into thin air. So a buying spree induced by high valuation is nothing new. AOL used its unrealistic valuation to purchase Time-Warner, a company with real assets, and Time-Warner has been trying to forget about it ever since.
One of the reasons I think the Google stock price is not sustainable is because more than 99% of its income comes from Adwords and Adsense, and these revenue streams are in persistent danger of being co-opted by spammers who are creating link farms and splogs to exploit them. If there were other sources of income, or even other potential income sources on the horizon, that would add some stability. But I just don’t see it coming with the other services they’ve acquired.
I’ve been experimenting with Adsense recently on my own webpages just to see what the fuss was about. With a .4% click through rate and an average of $.30 commission per click, I won’t be quitting my day job any time soon. If I had a Starbucks habit, the Adsense income could cover me for a day out of each month. With such meager earnings for a site containing real information that gets thousands of hits per month, it seems like a tough way to make money. I suppose my click through rate could be higher if the algorithms that did keyword searches were smarter. For example, on my Ham Radio page, evidently a company that sells hams (as in the meat) has outbid the companies that have Amateur (Ham) Radio equipment for sale ;-). Similarly, the rest of the ads are equally lame pitching items that I’m embarrassed to see on my web pages. I wish I could provide Google with a list of sure-fire keywords that I know would be better target readers rather than letting the algorithms do the choosing based on words on my pages. I’ll continue to run this experiment for a few more weeks and report back if things have improved at all. If not, I’ll try something else. It won’t be for the money, but just so I can have some first hand experience with keyword advertising services.
In reading about the recent AOL stock deal where Google bought 5% of the company, all I could think of was “Why AOL?”. Considering Google’s mantra is ‘Don’t be Evil’, teaming up with AOL seems to me as the ultimate sellout. AOL is completely bereft of anything of value other than their captive audience that they hang on to with a maniacal death grip. Like many others, I was an AOL member in the 1990’s. My difficulty with them occurred when I tried to drop the service after I signed up for broadband. First of all, AOL makes it impossible to forward or even export your email, so that works as a deterrent for dropping the service quickly because you periodically need to check it for email until you’re able to notify everyone of your new email address. But the true face of evil showed itself when I called up to cancel the AOL account and got the run around from their people who would make up any excuse to prevent me from quitting the service. I was told lie after lie and thought that I’d have to hire a lawyer to get them to stop charging my credit card. The depths that they stooped to prevent me from leaving were unbelievable. The only way I was able to quit was when my credit card number got stolen and they were unable to continue charging it. So I don’t have a lot of respect for AOL. And since dial-up is so completely dead, I have to wonder what keeps their considerable, yet dwindling, user base hanging on to them. Buying into AOL seems a little like jumping the shark and I expect that the end is near. Not the end for Google, which still has the best search engine available, just for its over-inflated stock valuation.
6 responses to “Google 2.0”
Lee Devlin February 20th, 2006 at 01:42
I do know the difference between Adwords and Adsense and apologize for using the terms interchangably, but to me they achieve the same result, i.e., Google using search technology in an effort to deliver targeted advertising. This constitutes 99% of Google’s income. And it’s an accidental business model by all historical accounts of what Google set out to do in the first place. After all, how can you provide unbiased search results if you’re getting paid to insert ads into them? Did you know that 60% of the people who use Google do not know which ads are organic and which are paid results? I can’t tell if that is evil or if it is just clever.
As for P/E ratios, Price to Sales ratio, Share Price, Profit Margins, and Market Cap, I don’t doubt that you can find outliers in each category that exceed Google’s numbers, but you will not find another example of one that can match Google in all categories. If you do, I’ll buy you dinner at Entcon this year. 🙂
I agree with you that share price alone means nothing, Warren Buffet has proved you don’t have to have a stock that splits, so absolute share price is not relevant.
PE ratios mean next to nothing when a firm is just about breaking even, but it means a lot when a company is generating huge profits. That is, the kind of profit that is simply not sustainable (like 43% EBITDA) because a lot of smart people are going to be going after the same source of income now that they know it’s there.
I don’t recommend that anyone buy Google stock, nor do I recommend that anyone who has it should sell it. I’m just saying that the stock is overpriced because I don’t think its earnings and revenue growth can continue on a trajectory to catch up with its Market Cap.
Jack Krupansky March 4th, 2006 at 02:25
You wrote: “As for P/E ratios, Price to Sales ratio, Share Price, Profit Margins, and Market Cap, I don’t doubt that you can find outliers in each category that exceed Google’s numbers, but you will not find another example of one that can match Google in all categories.”
I see that you’re still not willing to give up on Share Price, even though it sounded from your other statements that you were amenable to conceding that share price is completely meaningless. Let me assure you that Share Price *is* completely meaningless, although there are some technical issues related to transitioning below the $10, $3, and $1 levels, but they aren’t relevant to the Google topic, yet.
Market Cap is another completely meaningless metric. It tells you nothing. It is simply the product of the Share Price and the number of shares outstanding. There is zero useful investment information produced by that calculation.
I would note that Google’s P/E is actually *below* their trailing profit growth rate, which is *better* than most stocks. You really should the PEG ratio (P/E divided by expected growth rate), although growth rates are always highly debatable. If you looked at a bunch of PEG ratios for tech companies, I’m not so sure that Google would look so bad as to justify worrying so much about Google’s stock and it’s “investors”.
If you want to consider useful metrics, try Book Value (per share). Or replacement value. Not that Google would look so great, but no high-growth company has very much in book value and they always are priced well above non-human asset replacement cost.
In any case, you committed the fallacy of overspecifying your test, which is not a valid thing to do when setting a threshold value. You can always string together a long list of tests, but you also need to justify why those tests are *required* to meet a threshold value.
Meanwhile, Google’s stock begins to resume its climb! It’s up 5% ($378) since your price comment ($360), even after some sloppy reporting caused a minor scare about future growth.
If you keep saying unjustifiably negative things about Google’s stock “value”, you’ll probably end up convincing me to buy some!
— Jack Krupansky
Lee Devlin March 4th, 2006 at 15:52
I have a rule that I feel like I’m violating here. That rule is that I will not engage in public debate with anyone on the Internet. But since you’re a friend, and I am not trying to change your thinking, I will make a slight exception to the rule and continue to discuss this issue.
My only point in continuing this discussion is to let you know the one point on which you and I agree and others where we can still amicably disagree.
I agree with you that that share price means nothing. I KNOW this. And the reason I KNOW this can be summed up in two words: Berkshire Hathaway. BRK-A is trading at $87,000 per share. If a stock doesn’t split, it’s going to have a high price per share if the company continues to grow. So the absolute price of Google’s stock isn’t important to me.
However, I do think that Market Cap is vitally important. The total value of a company must be related to its expected annual revenue and/or expected annual profit. Google’s revenue and profit have an enormous amount of growing to do in order to grow into its current market cap. This means that those speculating in Google stock need to see the meteoric revenue growth continue in order to justify ever higher prices for the stock. Google’s CFO has admitted that’s not going to happen.
Google has a single source of revenue and I stand by my remarks made in the original posting. That is, that their primary source of revenue is under attack both from competition and from click fraud where nefarious forces are attempting to co-opt it for spamming, i.e., splogs and link farms.
Book Value? You want to talk about Google’s $10B Book Value? Say we value each of Google’s 175,000 servers at $1K (which is accurate according to Google’s VP of operations quoted in that linked story; most of them are assembled from cheap hardware available at Fry’s). That only gives us about $.2B. If they own the buildings in which these are housed (which I think is unlikely), as well as the Googleplex you’d probably have another $2B. So where exactly is the other $8B? My guess is that’s accounted for in good will and software assets they’ve created for search technology. But still, the company’s trading at 11 times book value which only strengthens the argument that it’s highly over valued.
Now I’ll be the first to admit that I can be all wrong about this. Google may be just about to launch some killer app that has a monster revenue model behind it. But looking at their past investments (Blogger, Keyhole, Picasa, etc.), it doesn’t seem so likely. They seem more attracted to investments by sheer technical elegance than by any promise of future revenue generation.
I may be wrong about the market penetration of Adsense. But if you look at any high traffic sites, their advertising is already sold out. Adsense is meant primarily for the little guys and they seem to have signed up already.
As for stringing too many metrics together to make my test meaningful, I will drop the requirement of Share Price, Profit Margin, and P/E ratio and leave just Market Cap and Price to Sales. Find another example of a company that has those two values on par with Google and I’ll buy you dinner.
To end, I’ll quote Peter Norvig, Google's head of R&D, with what he calls, Norvig’s Law: “Any technology that surpasses 50% penetration will never double again”. If you visit 10 sites that could support some Adsense advertising and half of them already have it, then I’d say that 50% penetration for Adsense has already occured.
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