Ten years ago, I called anyone buying into Google's much hyped IPO a "sucker." My bottom line, which I helpfully broke out into a separate paragraph titled "My Advice" in my Money magazine article was "stay clear." Man was I wrong.
In fact, few investing calls, since the beginning of time, have been more wrong. Leading economist Irving Fisher calling stocks cheap in 1929. And then there's me.
Google's shares started trading at $50, adjusted for a 2-for-1 split a few years later. I said they were worth less than half that, around $20. And I was pretty sure they would soon nosedive to that price. They never did.
A decade later, Google's shares now trade for $586. That's a 1084% return, roughly 10 times what the stock market did at the same time. If you had invested $10,000 in Google (goog) then, you would now have $118,400, or $97,000 more than what you would had if you invested the same money in the S&P 500. You're welcome!
So why was I so utterly wrong about Google? Can I learn anything about investing from this call?
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First of all, trying to come up with an exact price for what a company is worth is the true sucker's game. To come up with my $20 a share for Google, I used what Wall Streeters and finance professors call a discounted cash flow model. And I sought out the advice of New York University economics professor Aswath Damodaran, who wrote a textbook about how to value companies, to do it. Estimate all the money you think a company is going to generate over the next decade (because try to estimate beyond that and you are bound to look pretty silly), and then figure out what, based on future inflation, that cash flow would be worth today. And presto, you will know what Google, or any company should be worth.
Ok, so there were a number of ways to mess this up, and I did all of them. My first mistake was to assume that Google's sales growth would be a stable 30% a year. Online advertising was increasing, and I figured Google would get a slice of that. What I didn't understand was that Google wouldn't just get a slice, but nearly all of it. As a result, Google's revenue has grown an average of 50% a year over the past decade.
Also, I thought there was a high probability that I was overestimating how profitable Google could be. I said there was a strong possibility that Google would end up with Netscape in the internet graveyard. Based on its current profitability, I said Google could earn $48 billion over its lifetime. But that, I said, was unlikely. What's more, inflation would eat up the value of a lot of those profits. So I used a discount rate of 15%, per year, to figure out that the value of those profits was more like $15 billion.
Not even close. Google's actual cash flow over the past decade has been just over $90 billion, and inflation has been basically non-existent.
If I had gotten that number correct, and trusted it, I still wouldn't have predicted that Google's shares would be near $600 by 2014. But I would have thought the stock was a buy back at $50.
Second, some companies do live up to their hype. Actually, probably more than most of us expect. Damodaran, who I called up to chat about our decade old folly, said not to be so down on trying to value companies. He thinks you will be wrong 20% of the time. That seems low to me. A number of companies that I thought were successes a decade ago have faltered. But I can't think of eight high profile busts.
The companies that are still around a decade from now will probably perform better than expected. So the better question is not what the company will earn over the next ten years, but will it be around ten years from now. And then just assume if it is, it will do much better than you expect.
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Lastly, the companies that succeed are always going to be worth more than you think they are worth. That's the nature of the stock market. We're all chasing the same few stocks. And the market moves in herds. We think of the market and all the buying and selling as a way to come at the exact price a company is worth. That's the efficient market hypothesis. Instead, the market for stocks works like any other market. The good stuff always costs more than you think it should. And the bad stuff is always overpriced.
Bruce Greenwald, Columbia's reigning expert when it comes to investing, says I shouldn't feel so bad about being so wrong about Google. A decade ago, the search business still seemed in flux. So again, I would have had to have known that Google wasn't going away, and that it along with online advertising was going to take over the advertising world. In short, I had to know that Google was not just another Internet company, but the Internet company. I did not know that.
So here's what I think I have learned: A decade ago, I thought price was the most important thing when it came to investing in stocks. That doesn't seem right to me. The lesson of Google is that the most important thing when it comes to investing is picking the right companies. Get that right, and the price you pay for their shares is always going to be a good bet.
How do you know what companies will succeed? That leads me to my second, and more useful, lesson from my experience with Google: Buy index funds. I don't know the future. Do you? And you kind of have to know the future really well to pick individual stocks. So don't do it. Just buy the S&P 500. If the companies are successful, like Google, they will end up in the index eventually.
A few months after the IPO's success, when Google's stock had risen to the equivalent of $61, I again advised avoiding the stock. Instead, I said to buy eBay (ebay). Wrong, again. eBay's stock is up a pathetic 17% since then. Although I also said to avoid the shares of Yahoo (yhoo)--a good call, but not enough to get me off the hook for the worst investment call of all time.