Thursday, August 30, 2007

Response to Fortune Magazine article "Don't Go Gaga Over Google" by Geoff Colvin

To quickly summarize the assertions by Mr. Geoff Colvin in Fortune Magazine dated August 6th, 2007

- The business is dynamo, the stock is a pipe dream
- Earnings have been exceptional, with increased growth every year
- Only three companies have created more wealth (in respect to market cap) GE, Exxon Mobil, and Microsoft.
- Past performance does not always dictate the future
- Irrational valuations eventually correct themselves
- Google's economic value added (EVA), the dollar amount by which return on capital exceeds the cost of capital, will most likely fall short of expectations, pushing Google's stock price lower.

Colvin does a nice job getting to the point, while summarizing his valuation based on the EVA. Like Colvin, I tend to view a stock price from the efficient market hypothesis point of view, where all future dividends, profits, and expectations are already factored into the price of the stock today. However, this is a long term approach; therefore, interruptions and miscalculations by investors cause the price of the stock to vary in the short term.

However, the efficient market hypothesis claims that short term interruptions are not significant enough for the small investor to take advantage. This part of the theory I continue to question.

I think there are opportunities for the small investor to take advantage of these short term interruptions if they are willing to put in time to do research, follow a trading range (while remaining flexible to range changes), and accumulating both a short term and long term position.

Therefore, in a stock like Google (GOOG), an investor who remains bullish about the company should have both a short term and long term position, trading some within a range, and holding shares for the long term.

In the short term, I expect a lot of volatility from Google, from which a savvy short term investor could capitalize. However, in the long term, the market will get it right, and Google's share price will eventually move towards its efficient or actual value.

Recommendation: take both a short term and long term position in Google. Trading some shares due to minor market corrections, while holding some long term.

EVA recommendation: Eventually, Google will not make its lofty expectations regarding earnings, which should return the stock price to its efficient value.

I currently do not own shares of Google.

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