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Stifel Nicholaus (formerly Legg Mason) analyst Scott Devitt has had a "sell" rating on Google (GOOG) for a while, making him a rare contrarian on the stock. Here are the bullet points from his note to clients this morning, explaining his continued negativity on the stock:

The Tripping Point and a Revaluation; Maintain Sell

• We theorized that Yahoo!'s weakness was not company specific, but a sign of slowing growth among search providers. Google's report of in-line revenue and earnings reaffirms our theory.

• The bloom is off of Google, search is still a high-growth business long term and Google is the leader, in our view, but GOOG shares will likely face a period of consolidation as unrealistic expectations are tempered.

• In our opinion, it's not time to become a holder yet, but certainly the shares are more attractive in the mid-$300's than the mid-$400's. We're looking for an appropriate entry point and a more realistic set of expectations from investors.

• We maintain our Sell rating on GOOG shares with a 12-month fair value estimate of $400. We would be aggressive buyers in the area of Pi or the lower $300s, all else being equal.

• Google's net revenues of $1.29 billion slightly above our estimate of $1.26 billion. Diluted cash EPS of $1.54 and came in below our $1.75 estimate, though the tax rate of 41.8% was 10% above management's previous expectations. Normalizing for the higher tax rate, we come to a cash EPS number of around $1.71 per share. Sequential revenue growth of 22% was well below the most positive prognosticators at upper 20% to 30% range.

• Gross margins improved slightly to 59.6%, up from 58.6% last quarter. Net margin was sharply down sequentially from 36.4% to 28.9%. Google's effective tax rate of 41.8% was significantly higher than expected.

• Our 2006 cash EPS estimate is $8.72, up from our previous estimate of $8.30, and our 2007 cash EPS estimate has been raised to $12.00. Our 2006 and 2007 revenue ex-TAC estimates are $6.38 billion and $8.93 billion, respectively.

Our Thoughts

Benjamin Graham once said, "You are neither right nor wrong because others agree with you. You are right because your facts are right." We lowered our rating on Yahoo! shares to Hold prior to 4Q05 results due to valuation in the low $40s and we lowered our rating on Google shares to Sell following Yahoo!'s lower-than-expected results and guidance. We believe that Yahoo! is a very competent number two in the online media industry and when we saw a competent #2 miss, we believed it was time to head for the exits. Investors have been increasing expectations in the online media sector well beyond what we believed was going to be achieved in the near term and it worked given the fact that the core businesses of the leaders were outperforming expectations. Stocks were moving on guesses by investors as to which business Google would enter next. Thankfully, those days are now behind us and rational investors can begin to focus on what the business may be worth not where the stock may be going.

Excluding valuation, Google's quarter was extraordinary with revenue growth ex-TAC still north of 90% and full-year free cash flow of $1.62 billion. However, expectations priced into the stock were well above the performance that was reported as sequential revenue growth was 22% compared to the most optimistic numbers as high as 30%. We expect there to be a revaluation and the bloom is off the rose, but make no doubt about it, in our opinion, this is a phenomenal company. In prior work, we have brought forward risks relating to competition, click fraud, pornography, censorship, and others, and we believe each to still have relevance going forward. The investing business is a game of risk vs. reward and we believe that the risks we have laid out begin to be well priced into the shares in the lower $300s or around Pi, at which point we would be aggressive buyers, all else being equal.

The most relevant threat to Google over the intermediate term is competition from every media and Internet company in the world. We believe Google is well-positioned but competition and the increasing fixed cost structure now flowing through Google's income statement are cause for concern. Specifically, as it relates to competition and the belief that Google shall not fear, we point to Niccolo Machiavelli in The Prince, "There is nothing more difficult to plan, more doubtful of success, nor more dangerous to manage than the creation of a new order of things.... Whenever his enemies have the ability to attack the innovator, they do so with the passion of partisans, while the others defend him sluggishly, so that the innovator and his party alike are vulnerable."

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Source: Explaining a Sell Rating on Google (GOOG)