A while back somebody asked me what I thought of Google stock. My thoughts, then as now is; good company, but I would not trade their stock. Today I read something in Business Week that confirms why I am not a fan of Google stock.

The article talked about how employees will be able to sell their options instead of stock. Interesting idea, but I am not completely happy about it. The following comment from the article bothered me quite a bit.

Under Google’s Transferable Stock Option program, employees could sell their stock options on the semi-private marketplace much the way public options are sold today. That would let employees potentially reap more than if they merely exercised and then sold the securities. Say an employee holds an option with a strike price of $400, meaning it can be purchased for $400 and then resold at a higher price. If Google’s stock is trading at $500, an investor might pay $150 for that option, betting that the stock will rise well past $500 during the life of the option. The employee selling the option could net an immediate $150. An employee exercising and then selling the same option would net only $100, the difference between the strike price and the current price.

That should scare any investor who is thinking about buying Google stock. Cramer repeatedly says don’t think of Google as 500 USD stock, but a 50 USD stock. And if you think of Google as a 50 USD stock then according to Cramer there is no reason why it cannot go to 100 or 1000.

If Google is destined to reach 1000, why should Google care about letting employee’s sell options? I am thinking two reasons; Google is not going to reach 1000, and Google does not want to expense options as that would drag down their earnings.

From the referenced comment people do generally pay more for the option than the stock is worth. This is because traders assume a stock has volatility increasing the stock price. Though what is problematic with options is that they are a gamble that somebody has to write. That leads me to question who is going to write Google’s Transferable Stock Option plan. Normally its the company, and with the expensing of options things have become expensive.

For example, Microsoft estimated that, for the 12 months ended March 31, the effect of expensing options would have been to reduce net income from $9.6 billion to just less than $7 billion–a drop of more than 27 percent.

By selling the options to an investment house they are delegating the expensing and that concerns me. Let’s say you have company A that expenses options, and B that does not. How do you compare the companies using fundamental analysis? Answer, its very difficult.

The second problem has to do with the numbers stated in the article. Business Week says that an investor might be willing to pay 150 USD for a 500 strike price option. I looked up the 500 strike Jan 08 option, and it is priced at 64 USD (Dec 11, 2006). The market is betting a 590 stock price by Jan 08.

The article has overstated the premium for a 500 strike option, and that should concern you. I don’t think it would be a stretch for the writer to check the actual price for an option, and say the true trading range. Yet the writer of the article stretched things by quite a bit indicating one of two things; the article writer has no clue and that should be worrisome, or the article writer over-stretched to make Google look good and that should also be worrisome.

Though, let’s get back to the core issue of why sell the options and not excercise the stock? The answer is that Google employees can earn more money, and the investor is left holding the tab for Google’s lack of stock growth. In fact Google thus far has a bad buy back record (1, 2) and uses the stock market like a piggy bank.  

In the BW article it is stated that the problem with Google stock is volatility and thus employee’s are left in a lurch. I counter the problem is an over-valued stock that is not performing. At the beginning of 2006 the target was 600 USD (1). 

On Tuesday, Piper Jaffray analyst Safa Rashtchy raised his price target for Google to $600 a share for the next year.

This price target was set when Google stock was trading at 481, and it was set in Jan of 2006! CNN Money in Nov 2006 said the following.

Several analysts raised their price targets on Google to well over $500 and one analyst even slapped a $600 target on the stock after the company reported third quarter results in October that surpassed consensus estimates. Google has beaten Wall Street’s targets seven out of eight quarters since going public.

So now yet again, though with caution, the price target is 600 USD. Google seems to have done a sideways push this year.

Others argue the reason for a sideways push of Google is that people have a hard time with the high price of a single Google share. They compare Google to Berkshire Hathaway.

And after all, Google still has a long way to go before its stock has a price tag as rich as Warren Buffett’s Berkshire Hathaway. One class “A” share of Buffett’s investment company costs $107,300 while class “B” shares trade at a price of $3,584.

The comparison is faulty because if you look at BRK-A which trades at 107,000, the PE ratio is 13.84. Google’s current year PE is 90, and next year forcast is 60. What Google is saying is that next year they will earn more, but I fear not enough to bring the PE down to a sane level.

Again Google is a great company, but in my opinion a bad stock for the investor. Great for the trader, but bad for the investor. 

So how could Google improve the stock price?

  1. Buy back stock decreasing the PE ratio and split the stock.
  2. Get other divisions of Google to earn money.
  3. Create a virtual Google Desktop that allows a user to manage documents, emails, etc and charge a small fee for it. Think VMWare that can be local (Hard disk, USB drive) or remote (LAN, Internet).This virtual Google Desktop could run on any operating system at any time.