Why I’m Not Selling Google

It isn’t an easy decision by any means, but when people are paying you to make investment decisions for them, you have to step up and figure things out.

Peridot has had a decent sized long position in Google for many months now. What makes the decision even more complicated today is that I decided to put on a trade yesterday to play the GOOG earnings release. I bought the Dec 300 Puts and the Dec 320 calls, with the stock at $308. The logic was that GOOG would probably move drastically after the Q3 report, but the direction of such a move was hardly assured. Fortunately, we did get a huge move after the blow-out report that has some analysts pegging the company’s 12-month price target at $450 per share.

Even with Google shares up $40 today, I’m not selling. Of course, my first instinct was to sell, given that my strategy is to buy when others are selling and sell when others are buying. After all, the only reason Peridot is long GOOG now is because the crowd was selling immensely when the company’s IPO lock-up period expired early this year, presenting an opportunity for those who prefer go against the consensus view.

My rationale for not selling today isn’t very complicated. Yesterday the company was trading at 41x next year’s estimates, a level investors were willing to pay based on an assumption of how fast they thought Google could grow. Today we know that the company is growing at an even faster rate than we figured just 24 hours ago. However, now the stock trades at 40x 2006 earnings.

Google’s growth rate has gone up, and the stock’s valuation has gone down. In this particular case, I can’t justify selling the stock, despite today’s $40 gain.

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4 Thoughts on “Why I’m Not Selling Google

  1. Jack Miller on October 26, 2005 at 11:36 AM said:

    I made my 11th purchase of Google today at $354 per share. My basis is now over $200 with 400% gains in the first shares. The earnings explosion can continue for several more years as there is so much information that is not yet “organized”.

    The classified advertising business will never be the same when Google offers free searchable ads. A lot of newspapers are puckering up.

  2. DrTandem on November 5, 2005 at 10:40 PM said:

    Buy Google? Now? you have to be kidding! Now, that I have seen GOOG rise almost daily, I have this terrible urge to buy. That is my first clue not to do so.

    Google produces nothing. Most of the people who own it have no understanding of its business. Its business? Search. Currently, their search results suck! Those in the business have noticed that searchers have moved towards Yahoo and MSN.

    Why does the king of search suddenly suck? Because they just had a major update that was designed (opinion) to force advertisers and visitors to use their PPC (pay-per-click) ads. Guess what? PPC is a loser. No one (virtually) clicks on it the ads, except your competitor.

    “But Google is buying dark fiber and has Gmail and…” Oh yeah, telecom, that’s a real winner…NOT! That market is saturated and dominated by the Baby Bells and cable wanna-be-telcos.

    Google got to where it is by being innovative. Now they are nothing more than a dot com scrambling to maintain a revenue stream to keep their stock artificially high. “Dot com,” does sthat ring a bell? SELL!!!

  3. Shai Dardashti on November 13, 2005 at 12:22 AM said:

    Some perspectives on valuations:

    ===

    Sure, it’s “apples-to-oranges.” (Google is no Walmart – in terms of growth, margins, etc.)

    But they both are still fruit. (Meaning there must be some role of earnings in the company’s valuation)

    – Shai

    ===
    Editor, Shai Dardashti on Grahamian Value
    http://www.ShaiDardashti.com

  4. Chad Brand on November 13, 2005 at 7:24 AM said:

    Shai,

    Thanks for the links. I would agree that such discussions (GOOG vs WMT or BRK) are apples to oranges. Growth investing and value investing are two completely different animals, even in the world of tech stocks.

    I also agree that taking the value approach works well in tech, and provides less downside, when the focus moves away from growth rates and toward net cash positions, tanglible book values, etc. The latter methods work wonderfully and they can be used in the tech stock world, you need jsut dig a little deeper to find the winners.

    However, I continue to disagree with the many posters who continue to deem GOOG stock wildly overvalued. Companies growing at GOOG’s growth rate, with their margins, and with their potential, with 45x forward EPS multiples are not inherently overvalued. Most of those people who say so usually have just missed to the run from $85 to $385.

    It is true that if one buys GOOG at current levels and holds it in perpetuity, it will most likely prove to be a bad investment, as eventually the market will mature and GOOG will revert to “value” stock status, at which time the investor’s average annual return since purchase will be unimpressive.

    However, I think most investors, myself included, have no intention of holding GOOG forever. There will become a time where the growth prospects and valuation do not warrant holding the stock, at which time investors will sell, possibly initiating the stock’s fall from grace.

    However, if GOOG is able to capitalize on the growth potential that is clearly out there (of coutrse there is no guarantee they will), the company could deliver excellent growth for the next, let’s say, 5 years or so.

    Let me give you an example. Many might think these growth rates are unrealistic, but based on what companies like YHOO, EBAY, and AMZN have done, it would not be unprecedented in the Internet space.

    GOOG’s 2006 EPS are projected to rise 45%. Let’s assume a deceleration in growth rate of 5% annually for the 4 years following 2006, so 40% in ’07, 35% in ’08, 30% in ’09, and 25% in 2010. Again, GOOG bears will say this is impossible, with bulls saying it’s very possible. This is just an example of how some people see the stock right now.

    By this example, GOOG will earn $26 per sahre in 2010, up 25% from 2009. If we put a 25x P/E on those earnings, GOOG stock would be $650 per share. That equates to a 13% annual return for investors who buy today at $390 per share.

    Now, I’d be shocked in the S&P 500 returns 13% annually from 2006 through 2010, so in this scenario GOOG is not overvalued for an investor who has a 5-year time horizon.

    While I agree the stock will not most likely beat the market over the next 50 years given today’s high multiple, most investors do not plan on holding the stock for 50 years, so discounted cash flow analyses with terminal values, etc, aren’t a good way to determine if GOOG is overvalued or not.

    Full disclosure: Peridot Capital purchased GOOG at $170, sold about a third of the position at slightly over $300, and continues to hold the rest, with intentions of selling another portion in coming months.

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