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Google, Inc.
Sanity (Or Why People Didn't Learn a Lesson)

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By generatech
January 20, 2006

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Sanity (or why people didn't learn anything from the dotcom crash)

Google is greatly over-valued by three measures:

(1) Stock Price
(2) Technology
(3) Business Model


(1) STOCK PRICE

GOOGLE Price to Sales ratio:
26.3 (as of 1/17/06)

Market Cap (as of 1/17/06)
$138.05 billion

TTM Sales (trailing 12 months sales, NOT profit!)
$5 billion

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ANALOGY (based on Google's current financial percentages)
Hamburger stand revenue = $1 million (revenue, not profit!)
You buy their business for $26.3 million (the same ratio [26.3-to-1] as Google right now).

Without even measuring profit, your newly acquired hamburger stand must DOUBLE its REVENUE (not profit!) about 4.5 times just to EQUAL the amount you paid for it.

DOUBLE = 100% year revenue growth about 4.5 years in a row!
And that's not even profit we are talking about!

Now add profit to the analogy:
Google TTM Gross Profit: $1.7 billion (as of 1/17/06)
That's 1.2% of the cost of the company (the market cap).

So you paid $26.3 million for your hamburger stand, which grossed $1 million in revenue and profited $315,600 (1.2% of the revenue, same as Google).

$26.3 million for $315,600 annual profit. How many beeping years would it take to get your $26.3 million "investment" back?! About 83 years to break even! If their profit soared 300% to $1 million a year? "Only" 26.3 years to break even!

Or, in Google context, the market paid $138 billion for $1.7 billion profit. How many years would it take to get your money back? The same as the hamburger stand: about 83 years. And if Google's profit soared 800% to $13.8 billion a year? 10 years to break even, without the market cap going up, which it probably would.

NOTE: I barely escaped the last dotcom crash by selling my high-price-to-sales ratio stocks about 6 weeks before they tumbled (e.g., sold Inktomi in the $80s before it fell off the cliff; also, Yahoo et al.). I did this only after stumbling upon Fisher's old book, "Super Stocks," which focuses on the Price-to-Sales ratio. It saved my butt big time.



(2) TECHNOLOGY

Google is no longer a great search engine.

(i.) Google relies on the linking-popularity of a website not only to rank it, but to include it. It therefore excludes websites that have no sites linking to them. New websites that have no other websites pointing to them (i.e., linking to them) are not merely placed at the bottom of Google search results, they are completely EXCLUDED (i.e., not shown at all in the search results). I tested this with 4 new websites I created: Google hadn't found any of them after 12-14 months, yet all the other search engines I tried had found them. I then pointed my 4 websites at each other (i.e., provided links in each of the 4 websites that referenced each other) then added a link to one of them on a 5th site that Google already had found. Within a month Google included all 4 of my sites in its search results.

(ii.) Though Google is easily tricked when it comes to inclusion (but less easily tricked when it comes to ranking the included sites), the vast majority of small site operators probably do not know this.

(iii.) Another major problem is that there are too many websites in the world now for Google's non-categorized (non-grouped) results to be very helpful. Google presents its results as a long list on your screen. Search engines need to provide the top 10, 100, etc. CATEGORIZED GROUPS of found sites on your screen, not merely the top 10, 100 or 1000 sites found. (e.g., Clusty.com/Vivisimo.com categorizes its mass of search results.)

(iv.) Google cannot easily add on-the-fly-categorizing technology to its search engine without violating Clusty.com's/Vivisimo.com's patent.

(v.) Google's focus on linking-popularity came about before most companies had significant web presence. Now, because commercial websites are ubiquitous and de rigueur, Google's top search results too often fill with commercial websites. Again, Google is sorely lacking on-the-fly categorization of web results and also sorely lacks the inclusion of more websites than Google's reliance on link-technique crawling can deliver.

NOTE: Google's own online help explains their method for finding sites. My one-plus year test using 4 websites confirmed they rely on the outdated linking methodology, which made them great in the earlier days of the smaller web.



(3) BUSINESS MODEL


This question and answer illustrate the great failure of Google's business model:

QUESTION:
- What is the cost to the customer to leave Google and use a competitor's search engine?

ANSWER:
- Zero. There is no cost to the customer/user/client to switch to another search engine.

Unlike Microsoft, Google's primary product does NOT cost users when changing products/services.

EXAMPLE 1:
Leaving MS Windows requires several costly things:
(1) buying a new computer* (e.g., an Apple Mac; or spending labor installing Linux on an existing WinTel pc)
(2) learning how to use a new operating system (not as costly as it used to be, though)
(3) buying new software to run on the new computer
(4) learning how to use the new software

(*) also, the time (often dollar labor cost) of transferring data from the old computer to the new

SUMMARY:
Changing operating systems costs
- Dollars
- Time
- Productivity (at least in the short term)

GOOGLE:
(1) Dollar cost to a user going to another Webpage to use a different search engine:
$ZERO
(2) Time cost to user going to another Webpage to use a different search engine:
ZERO (or a fraction of a second)
(3) Time cost to learn how to use a different search engine:
ZERO (they all use the same interface of typing a word or phrase into a box then clicking a button)


EXAMPLE 2:
Leaving AOL costs a user less than changing operating systems or buying a new PC, but still costs more than leaving a web-based search engine, such as Google. These costs are the only reasons AOL hasn't completely collapsed (yet):
(1) Labor/Time cost: learning how to use a different email program and web browser
(2) Labor/Time cost: setting up the computer to connect to the Internet differently
(3) Labor/Time cost: notifying people that your email address has changed
(4) Labor/Time cost: transferring the address book and old email from AOL to the new email system

These are all more costly than the null cost of a Google user defecting to another search engine.


DIVERSIFICATION
Google must know all of the above. That is probably why they are gobbling up non-search engine products and services in an attempt to provide something that keeps customer from so easily defecting, even if users are only starting to do so (think about AOL if you don't believe the "yet" part). NOTE: a steadily increasing number of my own computer consulting business's 300+ clients (about 1,200 users) are clearly growing dissatisfied with Google's search engine.

- Email: offering Gmail is an example of this, but it is NOT good enough.
Cost to a customer leaving ANY company's FREE email service:
(1) Dollar cost: $ZERO
(2) Labor cost: address book and existing email transfer
(3) Labor cost: notifying people about your new email address

Nearly every element of Google's diversification is merely an element from unprofitable and/or tiny niche industries that will almost certainly be absorbed by Operating Systems within 5 years or will simply remain obscure tiny niches of profit:

- example - Picasa software: a tiny independent company that sold its product to customers. Google bought it and now offers the product for free to everyone. The writing's on the wall, though, for this category of software: the Operating Systems (Mac and Windows) will eventually include these features (Apple's iPhoto now bundled with the OS; Windows will eventually subsume it as it has hundreds of times with similar niche products offering useful file management services).

- example - Google Desktop: a niche product filling a void in the Windows OS. If Google Desktop is successful, Windows will add those features as it has hundreds of times with other niche products. (X1 Technologies offers a similar niche product, but not for free.) Apple OS X's search engine already offers most, if not all, of the search benefits of Google Desktop.

- example - business service/advertising: Google only gets ad revenue because it has users' eyes on Google's ephemeral products. It may indeed be a good ad buy for a business now, but when eyes leave Google (AT NO COST AS SHOWN ABOVE) the ad revenue will flatten or decline. In other words, ad revenue is tenuous because it's ultimately based on a product/service easily abandoned by consumers.


EXAMPLE 3:
Abandoning a publication as a reader.
Cost to a customer who stops reading a magazine or newspaper
(1) Dollar cost: $ZERO
(2) Labor cost: ZERO
What happens to ad revenue then? It goes down.


And what are Google's main offerings to keep a reader's gaze? An outdated teetering search engine and free email accounts, the latter already being offered by competitors galore.



DISCLOSURE & SUM


I do not own Google Stock. I am not shorting Google stock (yet).
I do not own stock in a competitor of Google. I am not shorting any competitor of Google. I wish Clusty.com/Vivisimo.com had stock so I could consider buying it.

I think Google's stock's Price-to-Sales ratio is irrational even if Google's business model was perfect. 26-to-1 is stupid, frankly, and though the gamblers and idiots may run the price up like they did during dotcom boom, it must come down from 26-to-1, regardless of how good the company may be.

PS I have been a Fool member since 1997, but under a different (non-paying) name.


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