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Wednesday, June 08, 2005

Misinformation and worry around Google (GOOG)

While I’m just as nervous as anyone with Google, I’m beginning to think that this might be a good time to reinvest in the stock. The following paragraph is from an article written by James B. Stewart for WSJ:

“No other company is like Google, but any valuation has to begin by looking at its two major peers in the Internet sector, Yahoo and eBay, with Yahoo being the closer comparison. Google's trailing-12-month price/earnings ratio was around 115 yesterday, nearly double Yahoo's P/E of about 60. EBay, further along its growth curve, has a P/E of 62, comparable to Yahoo's. Google's price/sales ratio is a lofty 21.3; Yahoo's is 13.4; eBay's is 14.7. Back at the time of Google's IPO, I met stiff resistance when I argued that Google deserved to be valued on a par with Yahoo and eBay. Now that Google's valuation has far surpassed that of its peers, I find people arguing that Google deserves even higher multiples. This worries me.”

Now, before I disagree with his analysis, let me say this: I love Jim Stewart as a writer. Den of Thieves is arguably on of the best business exposes of all time. But, he is falling trap to the same phenomenon that a lot of famous business journalists seem prey to; largely, they think that people should hear their opinion on complex topics such as valuing a high-growth company. Now notice I said, “should” and not, “want”. I have no doubt that many people would love to hear Jimmy’s opinion on Google’s valuation. He did write some of the greatest behind-the-scenes exposes about business, right? This is a subtle point, so I hope I can convey it adequately. Jimmy should now be asking himself this question: “Am I qualified to discuss this topic?” I would argue that despite being able to author many great books, that doesn’t qualify him to opine on topics like this. Has he ever worked for a hedge fund? Has he taken any courses on valuation? Is he a CFA (Chartered Financial Analyst? I think the answers to all of these questions is, “no”.

And that’s too bad because if he had any idea of what he’s talking about, he would realize that you don’t value a high-growth company like Google off of trailing earnings. Individual investors would be much better off heeding the advice of another commentator (and guy named James) that I do respect with regards to opining on valuation: Jim Cramer. Cramer has repeatedly pointed out lately the correct way to think about Google; namely that one needs to value Google on forward earnings. If you believe that Google will make $8 next year and also believe that it will continue to grow as fast as Yahoo! and eBay, then it should receive the same forward multiple, which is approximate 43x and equates to $344 a share. Now, consider the fact that Google is growing much faster than Yahoo! and eBay; this would imply that Google deserves a higher multiple than either of those stocks. Some people believe Google could make as much as $9 share.

So, isn’t interesting that the person who has extensive experience as a hedge fund manager, Cramer, has reached an entirely different conclusion than the journalist, Stewart? Which should you believe?

Now, one could argue that eBay and Yahoo! are overvalued, which is an appropriate argument. However, if you believe this to be true, then you would still want to short eBay and Yahoo! while maintaining a long position in Google considering that Google has a much higher growth rate. Additionally, one could argue that Google will not make $9 a share next year and that would also cause valuation concern, but I don't hear anyone using these arguments.

But, then again I’m not a journalist, so what do I know?


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