Henry Blodget recently posted an article stating the reasons Google’s stock is overpriced. There are, of course, plenty of people who feel that Google’s stock has only just begun its meteoric rise. Here’s my top reasons why Google is or isn’t overpriced.
Why Google is a Bull:
1. Smart people. Google uses its name to hire the best and brightest. In fact, even menial jobs are filled by honors students from Harvard and Stanford (I should know – I just lost a job applicant from Harvard to Google and trust me, the position they hired her for was very junior). Hiring smart people is one smart way to build good products.
2. Experienced people. Of course, hiring smart people isn’t enough – by itself. In the late 90s, a lot of dot coms hired freshly-minted MBAs and star students from the top schools. The problem, however, was that they were hiring these folks into vice president positions, in fields where they had no experience. I should know this too, as I was hired as a director of marketing for a start-up with exactly zero years of marketing or Internet experience and no subject-matter expertise to boot. All I had was a law degree from a good schools and I got the job. Google’s VPs all have years of experience, have had to go through the famously (or infamously) grueling Google interview process, and are measured with metrics that matter – like revenue growth – instead of ‘eyeballs.’
3. Brand superiority. Google’s brand – at least right now – can do no wrong. As I have discussed previously, every new product Google launches is immediately placed on a pedestal by all in the Internet industry. More importantly, Google has become synonymous with “search” for much of the world’s surfing population, not unlike “Kleenex” and “Xerox” have become associated with tissue and photocopying. The reputation of excellence Google has developed will keep people flocking to its products for years to come, irregardless of whether competitors develop superior solutions.
4. Superior technology. Although the difference between Yahoo, MSN, and Google searches gets smaller every day, its clear that Google is still superior and will likely always hold a lead over their closest competitors. Moreover, in the realm of revenue-producing products (like AdWords and AdSense) Google holds a clear technological lead over its nearest competitor – Yahoo Search Marketing (formerly known as Overture). YSM, as it is called, has a user interface that can best be described as anachronistic and has the speed of a tortoise running in wet cement. Google’s AdWords tool, on the other hand, is blissfully easy to maneuver for both novices and pros, is lightening quick, and has lots of tools and features that help advertisers figure out how to spend money on it. This difference will continue to increase the divide between Google and Yahoo’s search revenue.
5. Innovative culture. Google has embraced the “new economy” ethos more than almost any other company. But beyond the free food, massages, and beer parties, the most important thing Google has done is to reward and encourage innovation. Of course, every company claims to want innovation, but most big companies ending up fostering just the opposite by rewarding yes-men and employees who never take risks with promotions. Google, from the beginning, has let their engineers spend 20% of their time on non-core work projects and has actually funded and resourced some of these ideas (like Orkut and Google News). The result is a company that maximizes employee brainpower and comes out with some pretty darn cool things.
6. Confused competitors. Google’s stock should also be valued highly because Google’s main competitors have yet to demonstrate that they have a strategy to beat Google. Microsoft, for example, has been proclaiming amazing innovations in search and search marketing for at least three years now. The results, however, have been mixed at best. A recent ramp-up in paid search (MSN AdCenter) has been a positive sign, but Microsoft’s failure to successfully win AOL away from Google was concerning. Similarly, Yahoo has made some strides in paid search, with the introduction of the Yahoo Performance Network (YPN) being perhaps the most auspicious event, but has also continued to remain unfocused as a company, dedicating significant resources to a myriad of projects including courting movie studies ($100 million campus being built in Santa Monica) at the apparent expense of increased resources to fix what’s wrong with YSM.
7. Market euphoria. So long as investors believe Google can do no wrong, Google stock will continue to climb irregardless of virtually any other factors (with the exception of quarterly earning reports, of course). The blind enthusiasm for Google is reminiscent of the bubble fever of the late 90s, when stocks like TheGlobe.com, NetScape, and Internet Capital Group were valued as much on potential as they were on products or earnings. Google is far different from these companies in the sense that they actually already have massive earnings that are growing each quarter. Combine good results with stock hysteria and you have a stock that is poised to grow even more.
8. The growth of the search market. Search engine marketing has really only just begun. You can expect exponential growth over the next few years in terms of the number of advertisers involved, the money they spend, and the revenue Google captures from this growth.
OK, so as you can see, there are a lot of reasons why Google deserves to be a high-flying stock and could continue to see its stock price grow massively. Now let’s look at some of the reasons why the stock is over-priced and could soon fall in value.
Why Google is a Bear:
1. Google doesn’t expand beyond existing revenue streams. Right now, Google makes a lot of money from two products – AdWords (ads on Google and other search engines) and AdSense (ads on content pages of other sites). These two products are well-managed, growing, and very profitable. But, these products alone will not take Google to $2000 a share. Google needs to diversify its revenue streams. More specifically, they need to prove that all of the exciting new products they have launched over the last few years (Base, Earth, Gmail, Maps, Local, Orkut, etc) will actually end up substantially contributing to their bottom line. If these products end up being ‘cool’ but not ‘profitable’, this is a concern. Reliance on just a few products is bad for any company, especially one like Google that is investing so heavily in what are currently non-revenue producing initiatives.
2. Competitors get a clue. It’s possible that Microsoft and Yahoo will some day wake up and decide that they are going to do everything in their power to break Google. As I have noted in prior columns, Yahoo could do this by virtually giving away YPN – their AdSense competitors – for free to publishers, thus putting severe margin pressure on AdWords and stealing marketshare. MSN, in turn, could aggressively court Google’s AdWords partners (as they should have done with AOL) reducing Google’s distribution network. And both companies could invest heavily in search technology and eventually whittle away at Google’s competitive advantage.
3. Google becomes too corporate: Innovation drives Google and for Google to stay on top, they will need to continue to foster such innovation. It becomes very hard, however, to keep an innovative culture as a company grows. Even at 100 employees it is inevitable that some level of politics, laziness, and bureaucracy begins to creep into a corporate culture. Google now has something like four or five thousand employees. Google may be able to retain an innovative culture better than other 1000+ employee companies, but will that be enough, especially as new entrepreneurs continue to develop the next Google in another Stanford computer science lab?
4. Google loses top employees: Turnover is inevitable at any company but is surely an even greater concern at Google, where the stock price has made more than a thousand employees millionaires. And every point higher the stock climbs, these employees become richer and perhaps less interested in working period. There’s also a certain level of excitement that comes with building a business that fades away when it comes time to maintain a business. Many of the smartest early employees may decide that it is more interesting to go another start-up than it is to manage an established company.
5. Search engines become less valuable: Sure, everyone uses search engines today, but what about five years from now? The Internet is changing rapidly and there’s no guarantee that search engines will be the dominant form of finding information online in a few years. In fact, before Google came on the scene, a lot of people were proclaiming the end of search engines and lauding portals, verticals, and community sites. New technologies like del.icio.us and Flickr, social networking, and even blogs could effectively decentralize information gathering on the Internet, bypassing search engines altogether.
6. The euphoria ends: What comes up, must come down. Many stocks have risen as quickly as Google, and many stocks have received equally glowing recommendations from analysts. Some of these stocks have continued to climb. Others have struggled and eventually falled. And the higher one climbs, the harder the fall. If Google does someday have a quarter that fails to meet analysts’ expectations, you can be sure that the stock will drop. And fast.
7. Text ad blindness: Google makes virtually all of its revenue on text ads. People click on text ads a lot, far more than they do banner ads, in large part because people find them more relevant and less ‘ad-like.’ But, if consumers gradually begin to tire of text ads on every page they surf online, they may begin to ignore them altogether. In the late 1990s, banner ad click-through-rates decreased precipitously, creating a phenomenon known as “banner ad blindness.” If a new phenomenon of “text ad blindness” occurs, this will have a significant and negative impact on Google’s revenues.
8. Google alienates too many people: Part of Google’s new economy attitude is, well, an attitude. A lot of people in Silicon Valley have had bad experiences with Google. Most often, I hear people talk about the hubris and arrogance that exudes from the Googleplex. There’s also a sense among advertisers that Google doesn’t fully appreciate how much of their success is due to their loyal advertiser base. While some companies make sure advertisers are always taken care of (with parties, gifts, high levels of customer service, etc) Google seems to think that giving a $5 million annual advertiser a $45 Google-emblazoned blanket for Christmas is a sufficient thank you. Unfortunately, there are a lot of people who won’t shed too many tears (and may be actively rooting for Google’s dismise) if Google struggles.
So, there you have it. There’s a lot of reasons to like Google’s stock and just as many to hate it. I guess like any good investor I can say that I successfully hedged my bets on this one. And, whatever happens, I can also claim “I told you so!”