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Wednesday, June 15, 2005

Hussman: Google worth less than $40 per share (GOOG)

John Hussman's Hussman Strategic Growth Fund (HSGFX, a mutual fund that uses options to hedge long positons) has the best risk-adjusted performance of any mutual fund.  That's why his weekly letter is worth reading. In the most recent, he argues that Google (ticker: GOOG) is worth no more than $40 per share. The relevant extract:

Initially, I estimated Google to be worth about $24 a share. It has since enjoyed some very good operating surprises. I'd currently estimate its value somewhere in the $30's. No zero is missing in that last sentence, though the quickest way for the company to substantially enhance its intrinsic value would be to buy everything it possibly can with its own overvalued currency. Having made similar comments regarding the value of Cisco, Sun, EMC and Oracle near the peak of the tech bubble, with value estimates (which turned out to be slightly optimistic) at small fractions of their going prices, I'm pretty comfortable with that figure.

The difficulty with Google isn't in the product. It's neat. It's hip. I use it almost daily. The real question is this – why do we naturally assume that Google's revenues and earnings are going to grow exponentially from here? In a competitive market, with few barriers to entry and no particular brand loyalty, an advertising company that's valued at 1/5 the market cap of General Electric is not likely to mount a secure defense for its revenue stream. Unlike Microsoft, Adobe, or even Yahoo and Ebay, there's currently no benefit to users in aggregating around the same product as their “standard” (note to Google – this is really where you ought to be focusing your attention) and no high-cost obstacle to entry aside from smart statistical and computing algorithms. Therefore, there's no natural monopoly that would lead to a defensible competitive advantage. Sure, these guys are smart, and deliver useful, consumer oriented products. But when you value a company at 20 times revenues and over 100 times earnings, you're going to invite competition from some very, very intelligent people.

Given the company's business model, the long-term growth process is much more likely to represent a blend of logistic and extraction processes than the explosive exponential process that analysts seem to be taking for granted. And wow, will that make a difference over time.

My impression is that the explosive growth we've seen in Google's revenues recently has been very much a “simultaneous adoption” effect. With the enormous notoriety the company has enjoyed, it's natural that advertisers would want to try out that venue, and even pay a premium to do it. At present, however, the value of a click from Google is worth no more to an advertiser than a click from another source, so even if the value of Google's free  product (search) is good, the value of their paid  product (advertising clicks) is no higher than its competitors. And nobody, free or paid, has any inherent loyalty or reason to stay if another product emerges that is marginally better. This isn't the stuff that defensible profits are made of.

What investors seem to be doing is paying an awful, awful lot for future creativity. That might be reasonable, to at least some extent, if the company's dominant position in the industry had characteristics of a natural monopoly. But it doesn't. Usefulness of a product is insufficient for profitability unless it is coupled with scarcity. Why does Wall Street take it as given that the company will grow explosively into the indefinite future, much less maintain its profitability or market share over time?

To paraphrase Grantham, if Google is worth $300 a share, capitalism is broken.

John Hussman's full letter is here.

GOOG chart below.
Big1_10

Posted by David Jackson on June 15, 2005 at 10:24 AM in Sub-sector: Search, ticker: GOOG | Permalink

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Comments

Yes, but... Google has a lot of unrealized potential, even though revenues growth may deccelerate in the short term. I wrote about this recently.

Posted by: Danny Taggart | June 15, 2005 02:23 PM

The problem with targeting ads is that, quite simply, most people aren't looking to buy when they're browsing the web. I think it's a mistake to assume that you can turn a 5% clickthrough rate into 50% with more context.

Posted by: Adam Fields | June 15, 2005 07:12 PM

My instincts agree with you, web ads shouldn't work. And yet Google is making loads of money with them. There is a lot of work that could be done to make these ads more relevant, because right now they're very dumb. Maybe 50% clickthrough is extreme, but changing an ad from random to pertinent would make a huge difference.

Posted by: Danny Taggart | June 15, 2005 08:06 PM

No - you're missing my point. Web ads work to the extent that they work, for Google, for two reasons:

1) They've been able to deploy to a wide number of sources, and they're picking up on sheer volume. Google has made it extremely easy for people to sign up online and get ads delivered, and they take a cut from both ends (adwords and adsense).

2) There's some amount of click fraud going on. Click fraud is actually extremely beneficial to Google (and other ad providers) right up until the point where buyers realize what's happening and stop buying ads. I don't see this really changing in the very near future.

So, there's a baseline there for how well ads do, determined by how wide you can throw your net.

I suspect that targeted ads will work much better for specific cases where the user is already looking to buy something. Take, for example, a product review. I'd expect an ad for the specific product to do better than an ad for the class of products (laserjet XXX vs. laser printers in general), but that's also going to depend on whether the review was positive or not. If not, maybe a competitor's ad will do better. This is a pretty fine-grained semantic difference - maybe it depends on particulars of the review.

For the general case, it's a bit of a different story. Take an article about the Michael Jackson trial. Is someone reading that going to be more likely to click on an ad that says "Buy Michael Jackson records" than one that says "Buy records"?

I don't know.

Can you give an example of what you mean?

Posted by: Adam Fields | June 15, 2005 08:41 PM

I understand that not everybody clicks on ads (and thus, volume matters). But surely, those who do, aren't doing it randomly. So my point is simply that, for those people who are willing to click on ads, Google can do a lot better for them by giving them more relevant ads.

Click fraud is definitely a big issue, and I had a caveat about that in my original post. Google is now allowing advertisers to choose the sites where their ads are deployed, so this will act as a damper on click fraud. On the other hand, this will probably cut out small/unknown sites, which gets us back to brand advertising.

As for specific examples, I'm thinking of a discussion I read once. Two people were emailing each other (with Gmail) about how one of them can't drink milk (because he's lactose intolerant). Google served up ads for milk products instead of ads for lactose intolerance drugs. This is an instance where better intelligence would help.

The Michael Jackson example is interesting. Maybe the best ads would be those for "I love Michael" or "I hate Michael" T-shirts.

Posted by: Danny Taggart | June 15, 2005 10:27 PM

But you hit it right on the head - the people clicking aren't clicking randomly. There's already intelligence behind it, in the choice to click at all. That person who's clicking is looking for something. If you're looking for something, then you'll take the extra step to find what you're looking for, and having the ad driver do it is an incremental step.

On the other hand, if you're not looking, it's a much bigger step that the ad driver has to take to convince you that you are.

Posted by: Adam Fields | June 16, 2005 04:49 PM

I enjoyed your remarks and I feel that google loves click fraud just like ebay enjoys shill bidding. If you think about it google has some of the worlds best programmers and click fraud could be easily be solved, but it will never be. Online auction type business models are build for the House.

Posted by: Andrew | June 20, 2005 10:56 PM

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