Why I'm Rethinking Google

 | Mar 25, 2014 | 4:30 PM EDT
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I have been bullish on Google (GOOG) for a long time. But let's be honest, that hasn't been a particularly brave or difficult call.

Even as other tech giants such as Apple (AAPL) have stumbled, Google's inexorable march toward world dominance has continued. The company, it has seemed, could do no wrong. As competitors to its core search business emerged in various parts of the world and margins in that business declined, GOOG diversified and found other innovative ways to produce revenue.

Some of those diversifications have been more successful, or potentially are, than others. I am not sure that the world really needed the Chromebook, say, but Google Glass, the driverless car and the company's recent investments in robotics all have the potential to be big. But today's developments Google Glass have me rethinking my bullish stance on GOOG, at least over the next few months.

On its surface, GOOG's announcement that it would partner with Luxottica (LUX) to make Ray-Bans and Oakleys with Google Glass is great for the stock. The technology is moving from geeky test users to the mainstream. Hooray! But is it really that good?

One of the problems that Wall Street has had since the 1980s is that most of the big decisions are made by rich young men, so ideas that appeal to rich young men tend to get overvalued. If this Noam Chomsky article in the New Statesman is to be believed, it seems that Silicon Valley is falling into the same trap. 

Obviously I realize the value of young, rich men. Advertisers and marketers target them for the same reason that bank robbers rob banks: that's where the money is. but I see a problem with this particular pandering to them. Any analyst worth his or her salt has already made the assumption that, over the next few years, Google Glass will appeal to that demographic. Attaching Google Glass to Ray-Bans and Oakleys will be seen as genius by those who would probably buy the product anyway, but does little to broaden its appeal.

Sales to rich, young men are already baked into analysts' assumptions and priced into the stock price. I don't believe they are overdone particularly, but at these levels (forward P/E around 22x) and given the law of large numbers, GOOG needs to significantly beat expectations in order to move the needle and making a product more desirable to people who would probably buy it anyway doesn't suggest to me that that will happen.

I am not talking about a collapse here, just a correction. GOOG is still a phenomenally successful company. But just a belief that exponential growth is not inevitable could have quite an effect on the stock price. Using those current analysts' projections for revenue, a drop back to a market average 18x earnings gives a price of $930. A relatively minor reduction in earnings forecasts takes us to the same level.

In many ways, I am reluctant to give up on GOOG. It has been innovative when it comes to product development, sure, but more importantly it has shown great innovation when it comes to ways to monetize what it has. But in a period of diversification and even transition, monetization and margin must, at least temporarily, take a back seat to expanding popularity. Today's announcement can be taken as evidence that Google is falling into the trap that Chomsky talks about in his article and anything that in any way restricts that expansion could be a negative for the stock.

It could, of course, also just be that I am old and grumpy and don't like the idea of young people having yet another thing that we didn't have when we were their age. It could be. But at some time or another, one has to take a profit on even one's best investments and for me, when it comes to GOOG, that time has come.

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