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Summary:

A funny thing is happening to Google on the way to near-certain immortality. Its stock, it seems, is as fallible as any other. Consider the year-by-year appreciation of Google’s stock price: 2004: Up 126.8%, from the offering price of $85 to $192.79. 2005: Up 115.2% to […]

A funny thing is happening to Google on the way to near-certain immortality. Its stock, it seems, is as fallible as any other.

Consider the year-by-year appreciation of Google’s stock price:

  • 2004: Up 126.8%, from the offering price of $85 to $192.79.
  • 2005: Up 115.2% to $414.86.
  • 2006: Up 11.0% to $460.48.
  • 2007: Up 1.5%, as of April 12.

Google, which joined the S&P 500 a little more than a year ago, has since failed to outperform that index: The S&P 500 returned 16.5% in 2006 and is up 2.1% this year. So after two years of glorious gains, Google has since lived a life less ordinary.

What’s going on here? It’s well known that Google’s revenue growth rate is slowing, as it does with any company that is getting larger. But it’s not as simple as that. Google’s profit margins are rising. And investors can be awfully forgiving about slowing revenue growth if margins are getting fatter.

Whether or not you factor in traffic acquisition costs, Google’s revenue percentage growth has slowed from three digits to two in recent years. But its operating margin has risen to 33% in 2006 from 20% in 2004 (the year of its IPO), while its net profit margin has risen to 29% from 13%.

But as any investor knows, there are other factors besides profit growth at play in stock performance: things like financial transparency, speculative trading and liquidity. All of these have buffeted Google’s stock at one time or another since it went public, but liquidity – that is, the balance or imbalance of supply and demand for its shares – is right now the determining factor.

One event that is having an underappreciated impact on Google’s stock is the secondary stock offering in September 2005, which added 14.2 million shares to the 19.6 million already in the market. That offering began a gradual tilting of the balance-o-meter of Google stock in favor of supply over demand.

Demand for Google remained high in 2005 as the company blew away earnings in the third quarter ($1.51 a share vs. the Street’s estimate of $1.36) and Net stocks in general rallied toward the end of the year. But think about this: Google ended the first week of 2006 at $465.66. If you bought it 15 months ago, you haven’t made money.

The supply caught up with demand. If anyone was hot on Google, thinking it might fulfill the orgiastic fantasies of analysts who had a $2,000 price target on the stock, there was always someone more than happy to sell shares to them.

Google added to the supply of shares when it bought YouTube for $1.65 billion in a stock acquisition. Google’s 10-K says it issued another 3.2 million shares for that. Since those stocks were issued on Nov. 13, the stock has traded flat to down.

Then there are all those stock options that are starting to trickle into the total number of Google outstanding shares as they are vested and exercised. In a thoughtful article Wednesday, the San Jose Mercury News asked whether employees who are receiving the last of their four-year allotments of Google’s pre-IPO options will bolt.

The story pointed to the obvious cultural and HR questions that such events raise: will Google’s valued veterans move on to create startups that could steal Google’s thunder? Will a class-system emerge where wealthier employees are resented by the newly hired? Google, as you’d expect, is making intelligent moves to stave off these problems.

But from a liquidity standpoint, there remain problems. On the one hand, exercised options add to the number of stocks outstanding, further dampening demand. On the other, a stagnant stock price – like Google has seen for five quarters – could deter new hires who are motivated by the lure of options gains.

Google could solve this problem the way most tech companies do: by buying back its stock in the open markets. At nearly $500 a share, that’s a pricey proposition. And it would betray the company’s oft-declared intention to invest only in future growth, not its stock.

In the now legendary “Owners Manual” that Larry and Sergey penned for shareholders, Google swore that it wouldn’t care about capital gains as much as “doing no evil” and “making the world a better place.”

Now, like so many tech giants before it, Google is faced with the unsavory reality of taking cash that could be spent on its future and instead spending it on the unglamorous reality of stock buybacks. Whether it makes this move or not will have, in time, an increasingly bigger weight on investors and employees, past and future.

Kevin Kelleher is a writer living in the San Francisco Bay Area. He has a regular stock column at TheStreet.com and is a contributor to Wired, Business 2.0 and Popular Science. He has previously worked at Bloomberg News, Wired News and The Industry Standard magazine.

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  1. Likely because its Friday, this prompts me to take a financial markets view of things :) Great article that touches on several stakeholders and their considerations at play.

    General Issue employee options are seen as absurd in most industries. They make sense as compensation to those that are situated in roles where they ought to be held accountable for stock performance. Google is no exception and frankly the stock market always and rightly approached Google as just another stock always.

    I would be inclined to think that the lack of ‘upward annualized volatility’ in the stock-price reflects the keen foresight of Google’s underwriters. In a way they correctly anticipated non-normal performance of the stock. That is what the better financial market makers do best. In addition the slackness indicates, as you have alluded in your note, that there exist equally, if not more, attractive investment opportunities for investors. The question thus still remains one of capital structure for Google’s executive and how they view equity markets within that structure.

  2. Brad Gerstner Friday, April 13, 2007

    Kevin,

    Nice analysis. However, given the trillions of potential $$ for this or any other company that is deemed a “good investment” I have a difficult time buying into some abstract argument about “too much supply.” There is a lack of demand for Google’s stock for a reason – investors do not believe the risk-adjusted expectations for future cash flows (aka profits) are the highest and best use of their capital.

    What is fascinating about this from my perspective is that notwithstanding the company’s impressive market position and market out-performance, it current trades at roughly 19.5 X ’07 and 14.5 X ’08 EBITDA. This is significantly less than recent private sales in the space (Digitas @ 17X ’08); public internet stocks (Bidu, Ctrp, Akam) and no where close to where Amzn, Yhoo, and eBay were trading at this stage in their life cycles.

    For Google, the multiple compression (the amount somebody is willing to pay for a $1000 of profits) has occurred much faster than for their peers – which is an interesting topic for discussion. But ultimately all investments are governed by cash flows and profits. If Google’s profits which grew an astounding 100% in 2006 continue to grow as expected and the stock price stays where it is, this simply means that the company is becoming more of a bargain.

    And as we all know, bargains (especially in the stock market) rarely last long…

  3. “the company blew away earnings in the third quarter ($1.51 a share” – “Google ended the first week of 2006 at $465.66″.

    Maybe I’m missing something here, but you seem to be saying that the P/E is something like 77 on an annualised basis but the reason capital appreciation is reduced is oversupply?

  4. Good article. I agree with you that the increasing supply of Google stock has caused their price to stagnate. However, I do not agree that they need to repurchase shares to increase that price. I think they’ll be fine if they just stop issuing new shares. Because of Google’s growth, and because of the company’s popularity, I think demand for their stock continues to grow. If they just keep the share count the same, eventually demand will exceed supply and the share price will go up. Actually, I find it amazing that the share price has not gone down after the significant increases in supply. To me, that shows that demand continues to increase significantly.

  5. Kevin Kelleher Friday, April 13, 2007

    Heath: On a historical basis, Google was always absurdly valued – its profits were more than tripling annually at that time. As Brad pointed out, its current valuation based on future earnings expectations are much more reasonable.

    Mark: My post didn’t get into insider selling, especially by executives, which adds a constant stream of supply to the stock. As much as Google would like to ignore what its stock price is doing, it has to be becoming more and more a HR concern.

  6. RandomThoughts Friday, April 13, 2007

    Personally, I think the slowdown really has nothing to do with Google. Nothing has changed at Google, they suddenly didn’t forget how to make money, their profits are actually increasing.

    People look at the high price of their stock and begin to wonder if it is overvalued. Throw in a few institutional investors and hedge fund guys that feel like getting froggy with Google stock and you could have a very rocky situation if you are a Google stock owner.

  7. Executive liquidation and uncertainty in future cash flows.

  8. LULOP.org [opensource] » YouTube caps Google stock bull run ? Friday, April 13, 2007

    [...] writer at Gigaom puts forward an analysis of Google stock price stagnation in terms of oversupply of Google share from the 2005 stock offering and the YouTube stock swao [...]

  9. Bruce Judson Friday, April 13, 2007

    Kevin:

    This is a really thoughtful article.

    Here’s an entirely different take: Google’s revenue growth has been powered by two revolutionary products: Adwords and AdSense.

    The Company continues to churn out some really great innovations, such as Google News and Google Maps, but at this point the revenue contribution of these, and other new services, is (I believe) insignificant.

    The major growth in Adwords and Adsense use has occurred. Now, the Company is optimizing their performance.

    It seems to me your question is not whether Google is a great company or even fairly valued but why it’s value does not keep increasing astronomically. All of the above may cause investors to wonder whether — without any new revolutionary products — Google merits a continuing torrid increase in it’s overall valuation.

  10. AdvertiseSpace Friday, April 13, 2007

    I think the easy answer is that the stock was over priced to begin with and by not sliding, you could almost say that it going up by just the right amount. Afterall all the eggs at Google are in one basket which has to make at least some inventors weary.

  11. I know whats weighing down goog’s stock, they’re buying crap like doubleclick . . . unreal.

  12. Holy Christ! 3.1 Billion!!!

    Don Dodge thought 2 billion was wayyy too much …

    http://dondodge.typepad.com/the_next_big_thing/2007/03/should_microsof.html

    I do think that Youtube and DoubleClick are WAY too pricey acquisitions and missteps..

    Anyone else shares a feeling that GOOG mgmt’s inexperience is showing here?

  13. Google Buys DoubleClick: $3.1 Billion Bucks » Webomatica – tech, movies, music blog Friday, April 13, 2007

    [...] be some questioning whether or not Google’s success is sustainable, as GigaOM notes the stock hasn’t been on a tear this year. But for every article I see speculating that Google is weakening, I see another that points out [...]

  14. There are the macro-economic factors too…like the threat of a depression due to the housing market hanging over our heads. Advertising is a high-beta business, and stock buyers take that into account.

  15. GigaOM » The New & The Old – An Update Friday, April 13, 2007

    [...] columnist for TheStreet.com. I hope you enjoy his fresh perspectives on technology as much as I do. His first column on Google is just an appetizer of what’s to come. Share/E-mail | Sphere | Print | Topic: Asides, [...]

  16. GigaOM » The New & The Old – An Update Friday, April 13, 2007

    [...] columnist for TheStreet.com. I hope you enjoy his fresh perspectives on technology as much as I do. His first column on Google is just an appetizer of what’s to come. Share/E-mail | Sphere | Print | Topic: Asides, [...]

  17. What’s Weighing Down Google’s Stock? | Forex Advisor Saturday, April 14, 2007

    [...] Google, which joined the S&P 500 a little more than a year ago, has since failed to outperform that index: The S&P 500 returned 16.5% in 2006 and is up 2.1% this year. via GigaOM [...]

  18. Richie Greenberg Saturday, April 14, 2007

    Just looks like a very expensive share price… nearly $500 a share… wow..

  19. Nomadishere : Seeker of Truth » Blog Archive » 5 Insights Into The Google DoubleClick Deal to Take Over Affiliate Marketing And Banner Ads Monday, April 16, 2007

    [...] it generated quite a lot of [...]

  20. Leaving Google in Search of Act II « GigaOM Wednesday, October 10, 2007

    [...] at 12:51 PM PT | No comments It shouldn’t come as a surprise: some of the early Googlers who have cashed in their millions and are looking for new challenges are hitting the escape button. We wrote about this pending [...]

  21. Thanks for the good post.

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  23. from :::bioca77.blogspot.com

    Google technology, genetic differences are difficult to overcome, one after another took place
    Chinese test
    Friends who are engaged in philosophy of mathematics professor: he suggested that acceptance of each other examinations: are you the best stock players in major markets to observe the real opportunity for the scientific validation of Education:: Stocks forecast defined as the conscience of the sale value as a bulk sale:: Google technology, what genes are ???
    1. Google the word does not convey his ideas took place interfering with the KEY WORD
    2. It is not possible to appreciate the network information automatically result in a child’s education vary greatly disturbed and therefore the Chinese, said::: Big may not be good
    3. Since we can not lose the semantic network based on the basic functional requirements specify the translator to convey his ideas, after all-out communication
    4. There is no awareness of the country all day so how could a fancy meal shaky peace efforts Xie mystery?? Day was again driven off and I do not know baidu

    5. The Chinese cultural market is the world market, complete User’s and need to google is already difficult to abandon the Chinese scientific distal goal-setting can be expected of the O, or come up with proof to convince the Chinese department scientists have o We all know that in the future with a non – trusted translation of the Chinese cultural market, the service is free world-wide forces of market integration and competitiveness of winning ooooo
    6. How can the Chinese scientific papers at various angles BLOG = bioca77.blogspot.com obviously have a lot of miscellaneous and the definition of the core technology of the type characterized by application of the standard specifications, please you add fuel to the fire, especially google there are so many excellent employees should be able to come up with scientific-style logic of law _ although experts say _google although many people do not necessarily understand what is high tech philosophy personified technologies but also perhaps the key to the report that day to be sufficient to resolve the significant increase in the strength of international tutoring English in international trade Business Services makes the Chinese market has opened, etc., and may get rid of ms baidu yahoo, etc. to catch up with the idea of Zu killing at least its after perfecting the article should have direct proof that there is sufficient proof of its strength at least the logic of law and the concept of the word to describe the facts supporting tool to process before making the Critique is the world’s User movements are very much welcome the experts expect啦o

    7. No Chinese Chinese cultural market, with no future Internet business world stage mechanism for

    In real terms throughout the force will gradually shrink its market within three years that is out of the game when, after being forgotten because of the real market for China, not U.S. dollars was a big Shiyibaiyi

    However, the conduct of Chinese cultural and educational contributions to the Dictionary of Chinese wealth is a matter of concern thousands of physical and therefore more than one

    Therefore, a sum for the future How do you perceived???? Late, lamented the state of impermanence track the stock market cycle of peace?? Wise Technical genes to predict a winner for supporting the consideration of scientific facts, and therefore there are estimates o drive the necessary knowledge of the potential sale now oo

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    The authenticity of the scientific matter of this article, if asked, after experts in his book reports will be admitted if it is now seems possible, but after three months passed and so on when the various units to carry out a study such as::: Baidu ms yahoo and other companies access to critical report After warning by the fact that the base should be a natural opportunity to

    9) Jin Yong said Dugujiujian Xixingtaifa whether it is the logical laws of general education??
    10) semantic intuitions reflect the services in the future on how the web server service important?
    11) GOOGLE, said the Chinese should be no mathematical model of a computer program, but no mathematical model of how the operations (detailed mathematical concepts within the model described in this blog) so google should not fear that goes against the facts of this said, the conclusions of this type of technology in mathematics problem Kwan Kam-Why?

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