Why Google Is a Buy

They pledged to make no efforts to placate Wall Street and its analysts by "smoothing" quarterly results. They offered no quarterly guidance or efforts to reduce earnings surprises by making profit and revenue forecasts. They wrote: "A management team distracted by a series of short-term targets is as pointless as a dieter stepping on a scale every half hour." They were interested in long-term shareholders, not speculators or traders. So what did they get?

Speculators and traders.

After going public in 2004 at just $85 a share in a populist Dutch auction, Google shares nearly hit $750 in November. By mid-March, they were at $412, a stunning drop of $338 a share, or 45%, the steepest in Google's brief history.

The cause of this wave of selling? An Internet measurement firm, ComScore (SCOR), began issuing estimates that growth in Google's paid clicks was declining, reaching just 2% in the U.S. That's all it took: a mere estimate from a third party most people had never heard of along with vague fears of a looming recession. (For a taste of the negative media frenzy this generated, just search for "Google paid clicks.")

Good riddance to those fair-weather shareholders who sold on such flimsy evidence.

The Google faithful never joined the stampede, and I count myself among them. On the contrary, as a long-term shareholder, I used the decline to buy more Google shares, as I exhorted readers to do, most recently on Feb. 5. Last week, Google reported much better-than-expected earnings and said paid clicks actually increased 20%. As Google Chief Executive Eric Schmidt put it, "paid click growth has been much higher than has been speculated by third parties." The stock price leaped $90 on Friday, Google's biggest one-day gain ever. All too predictably, the Wall Street analysts who had put such store in the ComScore reports are now blaming Google for not giving them more guidance — which is exactly what Google has said it won't do.

I'm not blind to the fact that Google cannot keep growing forever at double-digit rates. But the long-term case for Google isn't based on paid clicks or traditional advertising. Google has created a radical new advertising model in which clicks can be linked directly to purchases. Call this click fulfillment. This is so valuable that I've heard advertisers say they would pay far more for this than they currently do under Google's auction price system. You could argue that it's especially valuable in a recession, when the yield on advertising spending is even more critical.

Google gained even more market share in Internet search last month. But apart from dominating its core ad search business, Google has other long-term virtues. The migration of advertising to the Internet is still in its infancy. Google's acquisition of DoubleClick will enhance its capacity in display advertising and offer advertisers a comprehensive, one-stop approach to Internet ad spending. Google's YouTube video service grows more ubiquitous by the day. Someday Google will find a way to monetize this remarkable asset, just as it did Internet search.

Even after the price run-up last week, Google shares represent good value. They've gained about 10% since I last recommended them, but if you believe in Google's long-term prospects as I do, and are prepared to stay the course, that 10% will eventually seem insignificant.

After this year's experience, perhaps investors will finally begin to take the Google manifesto seriously. Brin and Page were ridiculed by cynics on Wall Street and in the press for talking about creativity, challenge, innovation, risk and "making the world a better place." Perhaps this does require a leap of faith. If so, Google deserves shareholders willing to make it.