Why I Bought on the Google Dip

The web is full of chatter with people, including most analysts, who are musing about Google's (GOOG) earnings shortfall as a buying opportunity in its shares - but sheep or no, I'm jumping in a little.

I've been a Google shareholder for about two and a half years, but I did sell a portion of my holdings about 18 months ago - taking profits after my one year holding period partly because I was nervous about short term pricing, and partly because Google had become by far my largest holding.

Now, after a little share hiccup, I'm buying back those shares (for more than I sold them for, unfortunately, but for a price that I think is fair). I sold shares right around $400, and bought them back Thursday night at an average price of $508, which brings my average cost basis all the way up to $350.

Thanks to a portfolio that is much larger now, Google is not back to being my top holding, but it is now in the top five again.

Why did I buy?

Well, the short answer is that the earnings were too good not to at this price. I understand that the price run up to $550 was based on some probably irrational momentum enthusiasm, but I didn't think $550 was such a crazy share price.

Here's how the numbers compare from the March 2006 earnings release, when I sold a few shares, to today's news:

Sales:
March 2006: $1.92 billion
July 2007: $3.87 billion

Earnings:
March 2006: $372 million
July 2007: $925 million

That's right - sales about doubled, and earnings came close to tripling. Even though the margins are not what was hoped for in this latest release due to a hiring binge, that ain't bad long term performance.

Gross margins have been pretty steady over the past year at near 60%, though net margins are weaker. I'll take that over the opposite outcome (better net margins, worse gross margins) because it means Google's problems are cost-related, and not that its losing pricing power due to competition.

And that's really the key: here in the U.S., at least, there is precious little competition, and no sign that competition is niping at Google's heels despite Microsoft (MFST), Ask and Yahoo (YHOO) all launching improved services, and much better ad systems in the past year or so. Overseas, even in places like China where Google has market share problems so far, there isn't a single market where Google couldn't buy its biggest competitor without breaking a sweat, and overall, Google's international growth continues to outpace, even the very good U.S. results.

The "law of large numbers" argument, that Google cannot sustain its growth rate, is somewhat compelling, but it certainly hasn't impacted Google yet in a meaningful way. It's true that earnings growth has slowed somewhat due to investment, but we're still talking about near-60% sales growth, and a company that, I believe, is likely to hit an inflection point with their recent achievement of "full" staffing levels that may enable it to increase margins in coming years.

So, I can't argue with the market pushing GOOG shares down by a few percent today, as seems to be the final result. But the 8-9% hairdcut the shares got overnight, and early this morning was a bit overdone, and I'm glad I picked up a few shares.

I like the fact that Google is investing in more people right now, especially because many of them are overseas hires or hires who can help build Google's next generation of services. Google even indicated that a good portion of that 1% earnings miss may have been caused by the one-time $60 million impact of a change in its HR accounting policies.

But really, I just want to hold Google shares as a significant part of my portfolio, and this dip gave me a timely opportunity to restore that position when I happened to have cash on hand. Google beat analyst predictions for sales growth during a seasonally challenging quarter, and it's investing in the future with more engineers and salespeople.

I think we continue to underestimate the long term growth potential here, though Google will likely look expensive on a trailing P/E basis for many years. I'll try to ignore the quarter to quarter volatility, and keep my eye on the prize: world advertising domination.

Disclosure: I do own shares of Google, and am also a Google AdSense publisher.