Gimme Google

Google (GOOG)



Bought five times between January 26 and May 19, 2005 at prices from $182.20 to 239.37 (average price: $199.43)


Time to talk about Google for a moment, since they just released their quarterly earnings yesterday. Here's my one-sentence summary:

Google is the dominant network for serving internet advertising and should leverage their employees' innovation to continue that leadership as the internet itself grows in size and reach around the world.

Google and Berkshire Hathaway are more or less tied for the title of my largest holding, with each of them at roughly 10% of my portolio of individual stocks, though GOOG has grown into its position at about a 50% gain while BRKB has actually declined slightly since I purchased it. (And in the interest of full disclosure, you may have noticed that I make a very teensy amount of money through Google's AdSense program by allowing them to post ads on this site.)

I'm actually a little disappointed that Google did not decline dramatically in regular trading this morning, as I would like to be able to pick up some cheap LEAPs on Google to trade. I consider this holding to be a core one, not one that I'm interested in trading at this point -- I think the risk of missing substantial gains going forward is greater than the risk of losing the gains I have already achieved. I just don't see an end to growth, though I certainly can see growth being very lumpy for this still-young company.

(For those unfamiliar with LEAPs, they are long term options, available for both put and call. I sometimes use long term call options to leverage my position in a stock or give me a small trading position that I can use without selling my core holding. Back when the price was under $200 Google call options were actually extremely cheap, in my opinion, relative to growth -- they aren't any more, but I was hoping for a 10%+ haircut this morning that might make a bargain available)

Unfortunately, it looks like there are enough people who still want to get into a Google position and feel they missed the runup that any decline brings the buyers in pretty heavily -- we're down about 5% as I type this, but that's not much considering how gloomily the analysts are interpreting the earnings and the conference call with the CEO's muted warnings about the next quarter's growth rate. Somewhat unfortunate for those of us who want to buy more and would love to see a sale price.

First, on the earnings for this quarter:

I don't care that Google missed the average estimates slightly (though frankly, I think being within two percent can hardly be called a miss). I love that Google doesn't provide guidance, if only because it makes the analysts really sweat and earn their bonus money, but I was actually shocked at how close the average analyst came to the earnings number, just a couple cents off. I may have to reassess how smart analysts are. Now if Google had missed THEIR OWN guidance, that's another story -- that would tell you that they had mismanaged the quarter in some way, or that they didn't have a good handle on the business prospects. One very good reason not to give guidance at all, and certainly not to give quarterly guidance. In general, I think giving quarterly guidance just encourages a short term mentality and Google is following the Warren Buffett model, at least to some degree, in trying to build a huge class of individual shareholders who want to own the company (not just the stock) going forward.

But one thing I don't have to reassess is how singleminded analysts are -- they care about the current and coming quarter and that is generally all. In some cases, they care about "year from now" numbers and use those to project a price for the stock, but most of the words from their mouths are related to the coming quarter, the next earnings release, and foreseeable catalysts on the near term horizon that will move the stock one way or another. I'm not looking for the best time to sell Google in the next six months, so I'm not that concerned about the quarter's performance versus Wall Street expectations.

Google is ubiquitous, and it has become a verb -- I don't need to tell you what they do. They are synonymous with search, and have one of the fastest growing and most valuable brand names in the world WITHOUT ever having done any traditional advertising or marketing to speak of (Forbes estimates the value of the brand alone at about $9 billion -- I'd put it higher than that). That brand recognition is a large part of what investors are buying with Google, since it will remain a large part of their competitive advantage (or "moat" in Warren Buffett/Morningstar speak) in the years to come.

This is one case where being a verb benefits the company instead of weakening the brand -- unlike Kimberly Clark's frustration with seeing other facial tissues referred to as "Kleenex", I don't see a searcher going online to Google something and using any source other than Google.

So why do I like Google as an investment?

First, I like the company's culture and track record of innovation. I see this as an extraordinarily profitable advertising business that has room for great growth and spits off cash at such great profit margins that they can invest in R&D on a pretty dramatic scale. I like the company's strong focus on growing its employment base and adding more and more of the best engineers in the world -- more than 700 employees were added in just the second quarter, but even more than that I see great promise in the potential that can come from letting those minds loose. I think Google's policy of giving their employees designated time to work on their own ideas, which clearly comes from the founders and their academic backgrounds, is a brilliant way to foster a culture of innovation. This might be our generation's 3M, where even mistakes can lead the way to discoveries that create new markets (remember the story of the invention of the post-it? And 3M still tries to maintain that culture, which is a big source of their success -- one of their past CEOs says here, "You can't get innovation if you don't let people take swings. If people are going to get clobbered every time they take a swing, you don't get innovation.")

The most visible result of this is Google Labs -- if you haven't checked it out before, go to labs.google.com -- you'll see the stuff that, unlike Maps or Froogle or Scholar or Gmail, which are also all still in Beta but already better than their competitors, isn't even ready for wide beta release. Given the track record of their other products, including the new Google Earth which I love, I expect spectacular products to keep leaking out of Google Labs at even faster rates as they hire more and more of the world's best engineers and give them one of the the world's most powerful computer networks to play with.

I think there is a lot of room for truly dramatic growth going forward -- even though I certainly don't expect GOOG as a stock to remain on this 300% annual growth tear. There are two primary drivers of growth that I think are almost easy for Google -- increased internet and broadband coverage throughout the world, and increased global internet advertising spending. Good tables of combined statistics on this area are available from Internet World Stats, and the things that jump out at me are these:

• World internet usage has climbed almost 150% in the last five years, but still reaches just 14% of the population.
• Asian users already make up 34% of world internet users, even though only 8% of the population has access to the internet.

And internet advertising growth is remarkable -- fueled both by the increasing popularity and effectiveness of the ads and by the growth of internet and broadband users, interactive internet advertising reached $2.8 billion in the first quarter of this year according to the Internet Advertising Bureau, the highest amount yet in a series of nine consecutive quarters of growth since the market crash. E-commerce is here to stay and those online vendors need to advertise (Ebay is one of Google's biggest customers, if not the biggest), but Google and Yahoo and the other advertising networks no longer need to rely on pets.com for advertising as

I think those are growth trends that you cannot dispute or argue with, though you can certainly argue that Google might not be the dominant company worldwide that I see them becoming.

There is a good article from the SF Chronicle on the challenges that Google faces in its international expansion, including difficulty competing against entrenched local brands and services and creating quality products in other, particularly asian, languages. I expect that Google will continue growing organically as well as making acquisitions of smaller competitors. I do not particularly understand the practice of internet companies like Google investing in their up and coming competitors, as Yahoo did with Google many years ago before they were public, and Google in turn did with Baidu not long ago (Baidu, contrary to rumors that they might be acquired by Google, is filing to go public in the US).

This my biggest concern about Google, whether they will be able to scale their dominance in search and internet advertising in the United States and several other countries to the rest of the world.

What else am I worried about for Google going forward?

Volatility: obviously, Google is priced as though it can continue to grow at nosebleed levels for many years growing forward. Any hiccups in that growth could cause significant stock price declines, particularly in the short term. I'm not so worried about that, because in the end I think the business is so solid and the people have so much potential that the possibility of new avenues of growth evolving far outweighs the likelihood that they will become stagnant in the next five years.

Competition: Google came out of nowhere, so could their competition -- in theory. Google was an overnight success in search because it was wildly better than the unsatisfactory products then available. Google's competition would have to really set the world on fire to be wildly better, and with the increased size of the marketplace they would not be coming out of nowhere and I'd guess that any threatening small competitor would be very likely absorbed by one of the big three (MSN, Yahoo, Google). Google now has more than the best product in search, it also has inertia and the network effect working in their favor -- inertia because "Googling" is the default search behavior of most of the market in the U.S., and the network effect because of AdSense and AdWords. They have more advertisers than anyone else because they have a bigger and more productive network of sites, who they can pay more because they have more advertisers, and so on.

Valuation: At some point, margins will compress or growth will slow -- that' s what happens for every growing company, someday. But I would argue that Google is a long way from becoming fully grown. Look what happened with Ebay, even -- they are still off of their highs of last fall, but they dropped for six months because everyone was convinced that they couldn't find any new ways to grow and should see margin compression ... until this week, the street discovered that they are still a growth company, and a seemingly mature business suddenly saw it's market cap go up by more than five BILLION dollars in literally one day.

Google has a ways to go, and at a forward PE of 44 according to the analyst estimates (who I guess I have to start listening to since they came so close this quarter) I think today's price is pretty fair -- that's only 2-1/2 times the average forward PE of the S&P

Price: There are a lot of people who are really turned off by the $300 price tag and let that dissuade them from ever believing that the company is safe to buy. This is the Buffett influence again, and while I see the benefits of keeping the stock high as a way to dissuade day traders and speculators and try to foster a long term ownership base, I expect they will eventually split in order to remain a mainstream stock. And it goes both ways -- I think many people consider GOOG to be overvalued at $300 but would look differently at a company with projected earnings of .75 and sustainable very high earnings growth that they could get for $30. The decimal point makes a big psychological difference to some people.

I think that, senseless though it may be, a split will likely increase the price for Google a little bit at least in the short term (and perhaps increase the likelihood that GOOG will join the S&P 500 -- only Sears Holdings right now in the index has a price even half of Google's), and it will very likely increase the volatility. As someone who aspires to be a very long term holder of Google based on their future capacity for innovation and their focused and successful management, I secretly hope they never split the stock -- I'd love to be holding my Google shares in twenty years and looking at the lovely five digit prices I could get for them. But I'm holding either way. I do not expect to sell Google -- even if we have another stock market meltdown, I'll hold through it and I believe we'd see Google rise from the ashes on the other side (as Ebay did the last time around). The Internet isn't going away.

There are lots of folks weighing in on this -- I like the perspective of the search engine community, check out Search Engine Watch for one good blog with regular updates on the business.

technorati tags: Google, search

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Catch a falling knife?

Days like this are what makes me wish I had more cash on hand, while at the same time making me fearful of what I would do if I did.

The old stock market adage, "never try to catch a falling knife," is an apt one -- articles from various folks on just this topic are here and here -- but unfortunately, the urge to try is one of my weakest characteristics as an investor. Two cases in point today:

Shanda (SNDA), which I've written about before and which is one of my favorite Chinese companies, is falling for reasons I can't easily discern, and after climbing up above $40 for a little while after I purchased it it has now fallen down to near my original purchase price of $32. And that's in just a little less than two months. Business seems to be good, earnings should be quite strong when they're released, and the valuation makes it quite a bargain in my opinion -- forward PE of 16 for a company that's expected to have AT LEAST 30% annual growth going forward?

This one is always pretty volatile, so a 20% move over two months may not be a big deal, but it gets me itching to buy when it drops this far and I don't see a good reason for the drop -- although politics and competition are certainly always threats, SNDA is still the biggest force in the market and Chen Tianqiao is an icon of Chinese success. But I have to keep reminding myself, let it fall and watch for a while, don't buy just because it's cheaper than it used to be. Reconsider the fundamentals. Try to figure out why it's falling. Wait and see whether someone knows something you don't know. But also don't necessarily believe ridiculous claims like this one that "Shanda should do well because Microsoft and Marvel both also think massively multiplayer online games are a good idea."

And the other one that's collapsing as I type this is FARO technologies (FARO). This is a great company, in my opinion, with a spectacular product and very strong management. I first found out about them when they were a Motley Fool Hidden Gems recommendation back when I subscribed to that newsletter, and I really like the story. I have a full position already, but the hiccup in quarterly sales that they just announced has dropped the shares by about 14% last time I checked -- I want more!

FARO basically designs and sells computer aided design and measuring equipment -- notably the FARO arm, their signature product that allows extremely precise laser guided 3d measurement. They sell all over the world, and are even planning to build manufacturing capacity in Asia to meet the rising demand for their products there. Boeing just ordered 10 of the Arms, which was released along with the sales press release as perhaps a way to soften the blow.

This is one where I really might try to catch the knife, since it really appears to me as though they are falling just becauase of a little softness in the quarterly sales -- they still have a solid backlog of orders, and they have not changed their annual guidance (though this sure makes it tougher to make the annual numbers, as Bill Mann at the Fool wrote today), but some sales moved from Q2 to Q3. They are going to stop issuing these kinds of sales updates, probably with good reason, and they are going to only issue annual guidance, not quarterly, going forward. I like both of these decisions a lot.

But I am trying to be disciplined, so I am trying to wait.

You see, I've had some bad experiences. I bought Ebay when they surprised everyone this winter with bad growth numbers, just because I loved the business and thought they would come back. I ended up selling it a little while later because I thought other businesses, including Google, were more likely to grow my money.

I bought Overstock when they surprised everyone on the downside this winter as well, and I'm still holding but the chunks I bought at $58 and $53 are well underwater. I kept buying the falling knife later on, catching some in the $30s as well, so I'm close to even over all. Same with Provide Commerce -- another business I love, bought at $34 before they disappointed with Valentine's Day, then bought more as it fell at around $18. At the top of my writeup on Dreamworks Animation you'll note that I bought once before the troubles began this winter, then again after the Shrek 2 DVD problems pushed the price down to $31 ... but if I had waited, I could have picked up some today for $23. I still like the company in the long term and am holding, but I can't justify increasing my position any more even though it's now on even more of a sale (and who knows, maybe it will go down again after Wallace and Gromit this fall and I'll be tempted again).

The experts say that you should wait for a stock that's on a precipitous decline to "settle" and display a "bottom" before you buy in because it's on sale. I respect the opinion, and I understand that it comes from years of studying charts, but that smacks too much of technical analysis for me. I don't understand candlesticks or stochastics, and I never intend to, and the only bottom I really can pick out of a lineup is my own -- if I see a company go on sale that I already own or that I'm interested in, it really really really makes me want to buy in. I'll try to avoid buying the day that it falls and wait to see if the coming weeks will make it more of a bargain, but psychologically I think I'm more afraid of missing a bargain than I am of making a mistake and buying too high -- after all, these are companies that I really admire and believe in long term, so I have some faith that it will work out in the end -- especially in the case of FARO, where I think I understand why it's falling and am fairly confident that the market is overreacting.

So while I'm trying to be disciplined and wait for stable prices and the end of the decline (though if it was easy to pick the bottom, we'd all be rich), too much discipline really takes the fun out of this -- and if it's not fun why not just buy an index fund? I'll post any changes that I can't resist making to the portfolio, so all will be able to see if I'm an idiot.


Technorati tags shanda, SNDA, Chen Tianqiao, FARO, knife

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Rayonier (RYN)



Bought March 10, 2004 at $43.79

Peter Lynch wrote that you should never invest in something you can't draw with a crayon on a napkin. While I think that's a little simplified, I'm going to start each company-specific post from here on with a single sentence that summarizes why I like this company or investment:

Timber is historically the single best low-volatility and low-stock-correlation investment available to individual investors, and Rayonier makes money primarily from timber land ownership and management.

Rayonier is basically a timber and pulp company, but it's a bit more complicated than that brief description conveys. As one of the two major real estate investment trusts (REITs) that primarily holds timber land -- the other being Plum Creek Timber (PCL) -- it is one of the few ways to invest in this sector without owning a paper company or being a huge institutional investor who can buy your own chunk of the Pacific Northwest.

I bought Rayonier a few months after they converted to a REIT in 2004, largely as an investment in the long term value of timber and timber land as commodities. Rayonier and Plum Creek both looked attractive, but I liked the diversity of Rayonier's timber portfolio and businesses (more on that in a moment), and the fact that they were and are a smaller company with less attention from Wall Street. I also thought they had a stronger chance of raising their dividend moving forward, and because REITs are so often priced as simple income investments based on yield, that is always important. PCL is a good company, too, as far as I can tell, and it's certainly a larger company that has a broader portfolio of land holdings spread across the US (Rayonier is more focused on the Southeast, though they also own a lot of timber in Washington State and New Zealand).

There are several folks who have enumerated the value of investing in timber as a way to diversify holdings, since average returns are comparable to the stock market but with very little correlation to the market's movements (meaning that both the stock market and investments in a broad timber portfolio over a long term return about the same rate, but they don't move together so not all of your investments are going up or down at the same time). A couple of articles along those lines from investment advisers are available here and here

A lot of the recent discussion and renewed popularity of Timber as an investment class came after the stock market meltdown, not surprisingly, and I think one of the best articles about timber investing was written by Paul Sturm in SmartMoney about four years ago. In my opinion this article remains as informative and useful as it was then.

More recent writeups on Rayonier and other timber companies are available from the Fool, too, with coverage by Matthew Emmert, Bill Mann and Rich Smith.

The Rayonier and Plum Creek REITs are about as close as you can get to a pure play on the value of timber and timber land if you're a small individual investor like me -- there are several firms that set up timber partnerships or special investment packages for institutional investors, but that's for the cravat and cufflink set. And I'd just as soon stay away from the paper producers and other forest products companies like Boise Cascade or Weyerhauser -- for the most part, they're heavily in debt and reliant on specific sectors of the market, or have much more complex structures than we need, or just simply have different priorities and have stock market histories that don't particularly track to the value of their timberland holdings. More on Rayonier's non-timber business in a moment, but in general I'd rather focus on owning the land and the trees and managing the sales of timber than worry about whether Staples or OfficeMax is going to buy a big order of paper this month.

Since REITs must by law disburse the vast majority of their earnings to shareholders in the form of dividends, the dividends should in most cases be a good measure of the company's stability and ongoing performance -- Rayonier's dividend is at about 4.5% now, and Plum Creek's is at 4%. In my opinion that is indicative of the small differences in their holdings, and of the fact that Plum Creek is a bigger, older REIT that perhaps deserves a small premium.

And now some good news: Remember the warnings about different tax treatment for REITs? Usually, REIT dividend income is taxable at your income rate just like bond coupon payments or your paycheck -- REITs aren't included in the list of companies that benefit from the dividend tax cut to 15%.

But I said good news, right? Well, the good news is that for the most part, timber and land sales are classifiable as long term capital gains -- after all, what could be longer term than the 15-80 years that it takes a tree to reach logging maturity? -- so you'll usually find that a large portion, if not all, of the dividend from RYN is taxable as long term capital gains at, again, the friendly 15% rate. And last year, at least, about a third of the dividend was classified as return of capital, which is not taxed at all.

So unlike other REITs, this one's fine to hold in your taxable accounts and needn't be banished to the IRA.

At the top I said that Rayonier was a little different than PCL, and a little more than just a timber land bank -- how so?

Well, Rayonier has been around for more than 75 years, and they just recently converted to REIT status to maximize their after-tax performance for investors. During that time they have grown not only a huge portfolio of land, but a very strong business in high-end fiber production.

You see, Rayonier is really two companies -- one company owns and manages more than two million acres of land in the US and New Zealand (including selling parcels of land whenever it's deemed to be worth more for another purpose), and the other produces and markets what they call "performance fibers" -- ranging from the stuff that makes pampers so magically absorbent to acetate, filters and chemical ingredients and high-tech fibers that I can't pretend to understand. Sales are much higher for the fibers segment, at close to $600 million last year, but margins are much higher for timber, so timber and real estate brought in the lions share of earnings even though their sales were about half that of the fiber division.

So this diversity of businesses provides some limited diversification, bringing some growth and performance even when timber values are cyclically low.

And Rayonier is also very focused on "HBU", by which they mean "High and Better Use" as a property management concept. In terms that make sense to me, this means that if they can sell the land for less than they project earning through management and sales of the timber they could grow there, they will sell it and invest in more timber land that is less expensive and, presumably, in lower demand for other uses.

Why is that important for Rayonier, and how does that make them stand out? The way I see it, this might have a huge impact on the bottom line in the coming years -- Rayonier's holdings are focused primarily in the Southeastern United States, especially Georgia, Alabama and Florida. The area they are primarily targeting for High and Better Use -- which is something like 5% of their holdings right now -- is mostly in or near the high-growth coastal corridor of northern Florida and Southern Georgia, from Daytona to Savannah.

Timber holdings there have some competitive advantage in their proximity to end users or mills, but the price of developable land is so much higher than they paid, or could receive, for general timberland that even small marginal land sales can make a big impact on the bottom line. They are managing this very well, in my opinion, and according to their presentations this HBU property might make up as much as 25% of their holdings when you include more rural areas and the areas where better use might be conservation.

So this HBU aspect of Rayonier's strategy can provide a nice kicker to timber and fiber earnings and make continued dividend increases possible (divvy has gone up more than 10% this year), even when other aspects of the business might be stagnant. But it's just a small portion of the business, so not everything is riding on a continuation of the real estate boom in the Southeast.

This is a long term holding for me and it occupies a unique portion of my asset allocation pie that I don't see doing much trading in. While I fully expect Rayonier to fluctuate, I'm not watching it as closely as I do my more volatile stocks. I do not intend to sell unless there is a management problem, which for me generally means either that management embarks on a grand new strategy that I don't agree with, or they become justifiably tainted with fraud allegations, neither of which seems likely to me. Otherwise, I'm holding this as a way to diversify my portfolio with the commodities of timber and land (and a nice dividend), and hope that management can juice the returns a little bit above and beyond the performance of those commodities through growth in the fiber business and continued solid "HBU" land management.

If you'd like to see a different perspective, a guy at Kiplinger's thought RYN was overvalued and in trouble over a year (and 25%) ago.

technorati tags: timber, rayonier, ryn, pcl

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