The Google Opportunity
By James B. Stewart
February 7, 2006
GOOGLE SHARES FELL to earth last week, singed by earnings that fell short of wildly optimistic expectations and higher-than-expected tax rates.
You knew this day was coming, didn't you? No party goes on forever.
The plunge was swift. Google (GOOG1) shares were trading at $475 just a few weeks ago. After the earnings were announced last week, they dropped in after-hours trading to $379. This week, they dropped below $370. The thundering sound of fast money running for the exits was deafening.
My reaction: Good riddance. The higher Google shares climbed before some kind of correction, the harder they were going to fall. It's a relief to have this out of the way. And here's the silver lining: If Google is the company I think it is, this is almost certainly a buying opportunity for long-term investors.
Let's look briefly at the earnings that caused the havoc. Earnings were $372 million, up 83% from a year ago; revenue was $1.92 billion, up 86%. Margins, already above 60%, improved slightly. In other words, stellar results. "We actually think we had a strong quarter," said Google Chief Executive Eric Schmidt, seeming somewhat befuddled by the stock collapse.
All companies should have such problems. But good as they were, these results fell slightly short of Wall Street estimates, because analysts were using the wrong tax rate in their earnings models. The higher tax rate reported by Google accounted for all the shortfall and then some. Lost in the rush to sell was the fact that operating results were actually better than the consensus forecast.
Even so, the case for Google shouldn't be based on one quarter's results. Obviously the broad shift to Internet advertising is continuing to propel Google's earnings and revenues, and the margins suggest Google retains considerable pricing power. But Google isn't going to continue reporting 80-plus annual percentage gains indefinitely. No company does. But some companies have nonetheless done amazingly well over the years, turning their long-term investors who bought a hundred shares in the initial public offering into millionaires in the span of a decade. This is the kind of company I believe Google can be: an Intel (INTC2), Cisco Systems (CSCO3) or Microsoft (MSFT4) for this decade.
Take a look at the early trading patterns of Cisco and Microsoft after their IPOs (Intel's happened too long ago for the data to be available). Both are strikingly similar to Google's. Microsoft went public in March 1986. A year later, it had more than tripled. A year and a half later, it was up 450%. Then in 1987, it plunged along with the rest of the market on Oct. 19, losing more than half its value, a worse correction than Google has experienced thus far. Cisco went public in February 1990. A year later, it was up more than 150%. But then it lost more than a third of its value. Four months later it was up 250%. By comparison, Google was up 250% a year after its IPO, and 450% at its peak a few weeks ago.
These early corrections in Microsoft and Cisco were significant buying opportunities. At today's prices, Microsoft has risen 335 times, and Cisco is up nearly 300 times, from their initial offering prices. Of course there were no doubt companies with similar trading trajectories that ended up going nowhere. But it's only been a year and a half since Google went public. If Google does turn out to be another Cisco, it's still in its infancy, with plenty of gains ahead of it.
I still own my Google shares, and may well add to them. I've vowed to be the kind of investor Google's founders said they wanted at the time of the IPO: patient, supportive of management, not obsessed with quarterly earnings results, and not trading frantically in and out of the stock. In return, my hope is that Google turns into one those few companies that both transforms society and makes its investors wealthy. Opportunities like these don't happen very often.
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