Contrarians at the Gate

Everyone's jumped on the Google going up, up, up bandwagon. But now, inevitably, the contrarians are emerging. An interesting financial analyst blog, the Internet Stock Blog, presents an argument from fund manager John Hussman about why Google is really worth US$40 rather than US$300 or more.

Hussman offers some sober reflections, but I believe some of his assumptions and logic are flawed.

Here's the essence of his argument:

The difficulty with Google isn't in the product. It's neat. It's hip. I use it almost daily. The real question is this €" why do we naturally assume that Google's revenues and earnings are going to grow exponentially from here? In a competitive market, with few barriers to entry and no particular brand loyalty, an advertising company that's valued at 1/5 the market cap of General Electric is not likely to mount a secure defense for its revenue stream. Unlike Microsoft, Adobe, or even Yahoo and Ebay, there's currently no benefit to users in aggregating around the same product as their €œstandard€ (note to Google €" this is really where you ought to be focusing your attention) and no high-cost obstacle to entry aside from smart statistical and computing algorithms. Therefore, there's no natural monopoly that would lead to a defensible competitive advantage.

The skepticism around "exponential growth" is valid; we agree that there are some real, ongoing growth challenges. The point about competition is also valid. But his assumptions and arguments around consumer brand loyalty and barriers to entry are incorrect.

The high expectations make Google (and related stocks such as Yahoo!) vulnerable if they don't produce at high double-digit or triple-digit growth rates (which is impossible over the long term). That's one of the reasons you see companies like Yahoo! trying to further diversify the revenue base.

Google will need to follow suit and is aware of that. So look for some buying to that end in the not-too-distant future.

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