Testing the Google Conviction

By Dr. Duru

January 23, 2006

In early November, Google quickly hit my target of $400. At that time, I wondered what could come next. All I could offer was a chart that suggested GOOG was getting toppy and a caveat that the business appeared to maintain plenty of momentum. Two and a half months later, GOOG is right back at $400 after taking us on a wild ride to $475 and back down.

First we had talk of the disastrous effect of click fraud resurface last week. There was almost no effect on the stock - this was old news. However, on the 18th, GOOG gapped down viciously as it caved in to the pressure from disappointment in earnings news coming out of the internet sector. A spat with the Department of Justice over search records and a swift tech sell-off later, and GOOG finds itself down for the year. Friday's carnage delivered GOOG's worst one-day sell-off ever (-8.5%). How fitting it is that preceding this sell-off we witnessed an accelerating giddiness of upgrades and a race to rationalize the higest price target possible. I am sure many of these analysts were simply trying to catch up to the current momentum in the stock. Understandable. No one likes to get left behind. But now we have a serious test of the GOOG conviction. The gap down from the top, followed by three days of high-volume selling has taken the stock below the 50 day moving average. This smackdown makes a top look much more likely than the time when $400 first looked like resistance (see chart below).

The main change in this situation is the market's perception of what the future holds. I would buy any despair that comes from fear that GOOG's dispute with the Department of Justice is about keeping hidden some awful (or juicy!) business secret. The Department of Justice is not charging GOOG with any crime. We have a legitimate battle over a warrant (or lack thereof!), and I highly suspect that GOOG will win this battle. Even if it loses the battle, any material effect on its business will be quite temporary. To the extent the selling in GOOG is related to general market malaise, then the buyable moment becomes more complicated. I hope to talk more about those conditions soon. Basically, what I am saying is that GOOG's growth has not suddenly peaked - GOOG has clearly been making obvious moves to diversify its revenue-generating potential. Instead, the market's frantic optimism has peaked here. The market has suddenly chosen to take stock of the negatives in the GOOG story instead of blithely ignoring them. GOOG will report earnings in about a week, and you should bet that even the faintest smell of negativity will get quickly sold. GOOG will only survive that safari by delivering a pristine report card - something they have yet to do (remember the trigger-happy selling that greeted news of a seasonal slowdown?!).

So, while this test of the bull's conviction in GOOG's story (and the internet in general) is going to get bloodier still and even more painful, I strongly suspect that the party is not quite over yet. Stay tuned...and be careful out there!

DrDuru, 2005