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Sunday, January 29, 2006 - Page updated at 12:00 AM


Temptress Google may leave seduced investors red-faced

Bloomberg News

For investors who love Google, when the swooning ends, heartache awaits.

The Internet search-engine company has not only been overvalued, it has a lot of competition that may be overlooked by most of Wall Street.

Google had its biggest drop ever Jan. 20, down 8.5 percent to $399.46, after the Justice Department sued it over its refusal to hand over Web search information.

On Jan. 18, it fell 4.8 percent when Intel and Yahoo! reported lower-than-expected earnings and the share prices of those companies posted their steepest declines in more than three years.

On that day, analysts from Stifel Nicolaus and Standard & Poor's downgraded Google to "sell" from "hold."

Are Google's salad days behind it?

History lessons

No doubt, the people running Google are brilliant and have a great future. It's just that competition, economics and market history always seem to get in the way of a party that must end sooner or later. This year's "It Girl" is next year's Gloria Swanson. Just look at history.

Those who remember the nutty 1990s will recall a company called Cisco Systems, a perfectly legitimate maker of routers for computer networks.

During its heyday, few companies approached Cisco's high glamour. Around the time Cisco reached its highest intraday share price — a split-adjusted $82 on March 27, 2000 — a friend asked me whether he should buy the stock. Although I told him Cisco was overpriced, he bought it and lost money.

Cisco has been trading between $16 and $19 a share for the past six months. With a one-year total annual return of 4.5 percent as of this writing, it's no longer setting the world on fire.

Orchids to weeds

The list of orchids that turned into weeds is long: JDS Uniphase and come to mind.

Of course, not all tech debutantes crash and burn, yet for every "next Microsoft" there must be a thousand burnouts.

The 1990s odyssey brings us back to Google.

Few, if any, analysts said Cisco or companies like JDS Uniphase were overvalued at the time. Many opined the phrase uttered by anyone with market attention deficit disorder (MADD): "This time is different."

Google is still largely a favored child at the moment. As of Jan. 18, when Google plunged to $444.90 in U.S. trading, of the 37 analysts covering Google tracked by Bloomberg, only two were saying the stock will underperform and should be sold.

Six rated the stock "hold." The shares reached a 52-week intraday high of $475.11 only a week earlier.

One of the Google bears is Phil Remek of Guzman & Co., an investment bank based in Coral Gables, Fla. Remek says Google faces extensive competition in its search-engine business and is unlikely to continue its earnings growth based on his fundamental analysis.

"The company went through a hypergrowth phase in 2004 and 2005," Remek said. "While others see 40 percent to 50 percent annual growth, I see competition heating up significantly. They won't always be doubling and tripling earnings."

Competition hefty

More telling is the number and tenacity of Google's competition. When I inserted the term "search engine" on Google, I got 193 million entries. Sure, there's a lot of overlap there, but there's one competitive factor that can't be denied: Many other companies have search engines and emerging technologies.

Cash-rich Microsoft is also one of Google's competitors. While its search engine is a modest facsimile of the Google product, Microsoft can grab market share — and eventually advertising dollars — by bundling its engine with the company's many other software products.

"Microsoft will chip away at Google," Remek said, "and their competing products will get market share. Microsoft is playing a war of attrition. They are Google's most dangerous competitor and they're seriously underrated."

Future income

While Google Earth and its News search engine are neat, innovative products, Remek isn't convinced these now-free services will eventually produce reliable income streams. He says the new techno craze may be search and delivery of digital video files, now in its infancy.

Rarely is one investment perfect. It's far more prudent and profitable to diversify using staid index funds to cover all U.S. and international stocks, bonds and commercial real estate in the Vanguard, TIAA-CREF, iShares or Dimensional Fund Advisors (if working with a fee-only adviser) fund groups. I've done so and benefit from low costs and high diversification.

This strategy, contained in what I call a Nano plan of investing in passively managed index funds, is basically to diversify and hold. It boosts returns for the lion's share of investors over time and reduces risk. You can google this plan for yourself.

Copyright © 2006 The Seattle Times Company




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