Google is not a bubble


The strong run-up of Google stock price since its IPO last summer - its market cap has increased more than 300% since first listing - has prompted a rash of comments among market watchers. The prevailing view, particularly in Europe, is that Google market performance is just an unwelcome return of the Internet bubble phenomenon of late 1990s and early 2000. I beg to differ. I believe that Google’s meteoric rise reflects a reasoned view of its current position and of its future prospects. This is based on two considerations

Google is a top tier e-commerce company

Some analysts compare Google to companies such Webvan or boo.com or excite, ephemeral stars of the Internet boom. This is a mistaken comparison. Google is a top-tier company: its peers are the Three Musketeers of e-commerce (Yahoo, E-Bay and Amazon). If one looks at their long-term market evolution (since their IPOs), they have very largely outperformed broad market averages (and this takes into account occasional but quite brutal corrections all of them experiences particularly in the aftermath of the NASDAQ crash of 2001-2002). Anybody, who bought these stocks at their respective IPOs has made a return superior to 2000%.

Incidentally, this is not an unique phenomenon: if one looks at the top-tier companies of previous generation, such as Microsoft, Oracle, Intel or Dell, one can see a similar price behavior, where market leaders strongly and durably outperform market averages.

Current market is highly selective

During the bubble days, strong tide lifted all boats, solid ones as well as shoddy ones. This is not the case today. The market has become highly selective and discriminating. Google’s performance stands out because:
a. Broad market has been trading in a narrow range
b. Three musketeers have been underperforming recently, Amazon and E-Bay, more than Yahoo. This differentiation also demonstrates that investors are continuously evaluating prospects for each company and form distinct judgments about them.


Key performance factor: Google’s business model

From these considerations it follows that a higher ranking of GOOG is not based on a mindless whim or a sheepish investor behavior but on a reasoned judgment.
The question is what are the reasons for such, strongly bullish, judgment?
It is not primarily or exclusively the pertinence or elegance of GOOG search algorithm. Although, it is innovative and sophisticated, it is possible even likely that some lab or a start-up may come with a better mousetrap. Nor is it its popularity among users, always a fickle phenomenon. Nor is even its stellar financial performance (to the extent that this performance is a result rather than a cause of Google’s strategy).
The key explanatory factor is its core business model. It is this model that powered it to the top of online advertising. However for Google, the objective is not to become a biggest advertising agency in the world, although it may attain this position anyway.
In contradistinction to YHOO, it is not a media or eye-ball aggregation company. What Google is all about it is about monetizing information. We have all known for long time that information is the most valuable resource of the web. But, because of a widespread unwillingness to pay and conceptual difficulties of pricing it, the value of information was not being captured. It is in this area, that Google achieved a real practical breakthrough.
Its advertising programs provide not one but a series of mechanisms to fix, extract and transfer the value of information. It does so in full recognition of economic peculiarities of information: elusiveness, volatility, reluctance to pay. Google valuation and transaction mechanisms rely on third party payments (through advertising), dynamic pricing (auction) and pragmatic mixing and matching (paid search, contextual advertising, local advertising, etc).

Overshooting and undershooting

While the relative ranking of Google appears well-grounded, the questions of speed and magnitude of Google appreciation remain. It is difficult to ascertain whether its current price reflects its fair value. Furthermore, if past experience is any guide, violent price swings can be expected. The evolution of Google’s market price and valuation reflects an intense interplay of available information and constantly evolving expectations. Furthermore, equity markets today are not only anticipatory but they seek to cash in on those anticipations. This creates a continuing risk of overshooting or undershooting (like in the FX markets): the price is either too or too low. However in this case, there is a clear and rational upside trend.

published on Interactive Investor (www.iii.co.uk)