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Investors eyeing Google should do another search


Dear Mr. Berko:

What is your opinion of Google and its management? I’m thinking about buying 50 shares at the current $138.37 price. I use this Internet search engine at least five or six times a day, and many others use it more than I do. Please tell me if you think this is a good idea or if I should stay away from the stock.

H.E., Erie, Pa.

Dear H.E.:

The brainy guys at Google Inc. (GOOG-$138.37) took a page from Frank Sinatra’s book and told the Big Mean Wall Street Machine: “We’re going to do it our way.” And they really did! Management elected to democratize their initial public offering; they priced the shares (fairly) and made sure that the majority got into the hands of ordinary investors.

The “Google Way” cleverly tweaked the nose of the Machine and significantly reduced Wall Street’s fees by many millions of dollars. If you were a small or large investor who wanted to buy shares in the new offering, all you had to do was log on to ipo.google.com, select a bank and submit a bid for the number of shares you wanted to purchase. The allocation of these shares was effectively taken from the posh board rooms of white-shoe investment firms (who would have sold GOOG to their wealthiest and most influential clients) to an auction process that was open to anybody who would buy a minimum of five shares.

Google’s IPO was an instant success; it was priced at $85 and scurried to $113 the same day. As a result, many venture capitalists are now carefully analyzing the Google Way. Most venture capitalists have never been overly fond of the existing IPO process or Wall Street’s patronizing attitude. Any new idea that lessens their dependence on the Machine would be greeted with joy.

However, I wouldn’t be a Google buyer at $138.37 because I think the price is too high. In 2002, GOOG had revenues of $440 million and earned 45 cents a share. In 2003, revenues grew to $1.4 billion and GOOG earned 51 cents. This year, the company should earn (S&P estimate) $1.24 per share on revenues of $2.7 billion. Therefore, GOOG shares are trading at an overly large 112 times earnings. Heck, even my two kids aren’t worth 112 times earnings.

In 2005, the Street believes that revenues will increase to $4.4 billion and that earnings will come in at about $2.25 a share. Those are good numbers but that’s still an uncomfortably high 61 times earnings. Considering that Yahoo and Microsoft are aggressively investing in the search engine business (with proprietary algorithmic search offerings), I feel GOOG is overpriced.

Because I think a reasonable price-earnings ratio for the company is 35, it would have to produce earnings of $3.95 per share to trade at $138.37. That means the stock’s trading price today is where it should fairly trade in 2007 if earnings can reach that level.

GOOG is cool beans but I think its revenue growth will begin to slow, and I believe the effectiveness of its advertising will begin to wane. When I use Google, I don’t pay a whit of attention to the advertisements on my monitor, and that’s becoming the norm with most users. So, in effect, many advertisers are now getting a smaller bang for their buck. As a result, GOOG, Yahoo, Microsoft, Lycos, Ask Jeeves and other search engines might have to lower their advertising rates because those pop-ups are being X’d out and their effectiveness is diminished. It’s sort of like changing TV channels when the commercials come on.

Don’t buy the stock at this price. GOOG’s growth will likely become stale in a few years because Microsoft, Yahoo, Lycos, Ask Jeeves, etc. are all competing for the same eyes. I don’t expect compelling growth in the numbers of people using computers, and it’s reasonable to assume that GOOG may have a hard time competing against Yahoo and Microsoft for new eyes. If Google has a sell-off to the $75-$80 level, I’d consider owning the stock. But not at $138.37.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net.

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