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10 Years of Google and the Importance of Long Term Thinking

“Google has a huge new moat. In fact, I’ve probably never seen such a wide moat.”Charlie Munger, 2009

Google celebrated the 10 year anniversary of its IPO last week. Google is a company that I’ve never owned (unfortunately), but really admire. There are a few businesses I almost root for, like a fan of a football team. Costco, Fastenal, and Walmart among others are on the list. These are really high quality businesses that have made their shareholders wealthy over time.

Google is also on that list. I read an article in the Wall Street Journal that referenced Google’s initial prospectus (the filing that every company files with the SEC prior to listing its shares publicly). The prospectus is generally a great document to read, even for companies that have been around for a while. There are usually interesting nuggets of information, and many things you won’t find in the standard K and Q docs.

Anyhow, I read through the prospectus from 2004, and thought it would be interesting to take a look at a few numbers from Google’s first decade as a public company.

Let’s look at the results first. Take a look at the chart from the last 10 years:

Google Long Term Chart

The stock price appreciated from a split adjusted IPO price of $43 to $597 (that’s a 30.2% compound annual return for those shareholders smart enough to have held onto their stock through thick and thin over the past decade). And even more interesting, this 30% annual return came from a stock that sported a P/E ratio of around 60 when it began trading in 2004!

And this result has occurred even as Google’s multiple has shrunk by more than half (we hear about “multiple expansion” in investment theses all the time–this is “multiple contraction”. The P/E ratio was cut in half over 10 years even as the stock appreciated 11 fold).

I wrote a post last week about not caring about what the market does. If you own quality businesses that produce ever growing free cash flows and high returns on the capital they invest, then you shouldn’t worry about whether the S&P is expensive at 18 times earnings. And to be even more counterintuitive, sometimes stocks such as Fastenal, Walmart, and Google can turn out to be fabulous bargains even though they have seemingly expensive looking prices relative to earnings.

A Bargain Relative to Earning Power

As Ben Graham said in The Interpretation of Financial Statements:

“…the attractiveness or success of an investment will be found to depend on the earning power behind it. The term “Earning Power” should be used to mean the earnings that may reasonably be expected over a period of time in the future.”

After all, bargains are simply things priced for less than what they are worth. And the worth of a business—its intrinsic value—is measured against its future earning power, not the level of earnings it happened to achieve in the last twelve months. Google didn’t have a lot of the latter (when measured against its 2004 price), but it had plenty of the former.

In fact, you could have bought Google at a valuation of around $30 billion in 2004. To see what a bargain Google turned out to be (even with a high P/E), compare the $30 billion valuation in 2004 to the Google of 2014—one that made around $12 billion in after tax free cash flow last year and has $59 billion in net cash in the bank!

Indeed, Google was an undervalued stock in 2004.

A Look Back at the Decade of Google

However, my point of the post is not to lament the fact that most value investors missed out on Google. It may not have been prudent to invest in Google in 2004. It certainly wouldn’t have been for me. Very few investors had the foresight and the competence required to have taken advantage of a company such as Google in 2004—one that operated in a rapidly changing and newly developing search industry. But often times omitted investments (successful investments that made someone else rich) can be great learning exercises.

The point is to study a business that has been wildly successful, to try and uncover a few clues about why Charlie Munger thinks Google has one of the widest moats he’s ever seen.

This post is not this type of comprehensive study. But I thought it would be fun to take a look at some numbers from the past decade along with a few clips from the 2004 prospectus document.

First, take a look at Google’s numbers from its birth in 1999 to the year before going public in 2004:

Google 1999-2003 Financials

It’s incredible to think that Google was once a company that had $220,000 in revenue for a whole year. It’s now a company that grosses that much every 90 seconds.

Also notice that—unlike many tech companies—Google was very profitable at the time of its IPO with a 23% operating margin.

The Importance of Management and Time Horizon

We would request that our shareholders take the long term view.” –Google Original Letter to Shareholders, 2004

A deeper analysis would be needed to try to answer the questions about why Google has become so successful. But one thing to study is the management team and the founders.

Like Jeff Bezos at Amazon, the founders write a letter to shareholders. Interestingly, Brin and Page also reference Warren Buffett’s essays, letters, and Berkshire’s “owner’s manual” as inspiration for their letters and communication with Google shareholders. Here is the original intro to the first letter that you can find on page 27 of the registration document from 2004:

Google Letter Intro

Also like Bezos at Amazon, the founders at Google had very large aspirational goals, and they think for the long term:

Google Long Term View

Brin and Page knew from the beginning that a business should be focused on increasing earning power and shareholder value, not on meeting analysts’ expectations and quarterly numbers:

Google Long Term View 2

To Sum It Up

To summarize the post, here is a look at some of the numbers from Google’s 2004 results compared to the current numbers from 2014:

Google 10 Year Numbers

It’s hard to predict the next business that will compound at around 30% for a decade, but it helps to look for clues from the successful ones of the past. Great management teams are usually essential, and the qualitative factor of “thinking for the long term” should not be underappreciated.

I’ll leave the comprehensive analysis of Google for another time or for someone else, but I enjoyed paging through the old filing from 2004 and reading the letter to shareholders.

Have a great weekend!

16 thoughts on “10 Years of Google and the Importance of Long Term Thinking

  1. Great article!

    I agree it is difficult to have the foresight to predict these things. Looking back now wasn’t it obvious to realize that the internet search model business was basically a newspaper classified section? With that mental model one would quickly realize that the market reach would be potentially the world and the first one to gain popularity would win… well I guess almost (yahoo).

    I think it becomes important for investors to have a general concept of all the different business models out there. With just the basics it increases the odds of you realizing major disruptions in the making before it becomes obvious to everyone else.

    1. Yes, I agree. I think there are a number of mental models that one could be applied at Google. It’s a good case study to learn from. Lots of intangibles that have created value there also. I remember Glenn Greenberg saying that all the smartest young engineers would be wanting to work at Google rather than Microsoft or Yahoo. I think that helps solidify their position and deepens their talent pool.

      It’s a great business to study.

  2. This Google analysis has selection biase written all over it. We get a rationalization of the causes for success after the fact. Why don’t you buy the company now since it has the same leaders and long term orientation? and it’s much cheaper too! My guess is that you’re hesitant for the same reason people were hesitant in 2004. It’s easy to look back than to look forward!

    There will always be a market darling in any time period. Rationalizing their success is much different than predicting their success at the onset, and most likely, it’s NOT because of the reasons you specified. Most likely, GOOG succeed because they hit upon a good product at the right time, which is most likely the best description for the success of most market darlings. You’re fooling yourself otherwise.

    1. Hi AA, Thanks for the comment. Just to clarify, this isn’t a Google analysis. Just some general observations I decided to make after reading their 2004 registration doc.

      As for selection bias–yes, of course there is selection bias. I picked the company to read about precisely because of their results. This wasn’t random, and wasn’t intended to be. It’s no different than why other teams study the Patriots or the Spurs. They selected them specifically because they have achieved enormous success and they feel there is something to learn from that success. I suppose you could say that studying any successful business could be labeled selection bias. I guess any conclusions you draw from a non-random sample space could suffer from this error proned approach. But the alternative is what–picking names from a hat? I don’t really buy the whole concept, as I think it’s an academic term that doesn’t really apply to real world situations. It’s just not the way the world works. Teams study the Spurs because they are the best and they try to glean wisdom from Popovich and his approach. It doesn’t mean that they’ll draw accurate conclusions, but I think it’s better than putting 32 names in a hat and drawing teams at random. This isn’t designed to be a statistical study or a backtest. It’s designed to try and draw conclusions from a firm that–after a biased selection–has experienced enormous success.

      You’re right in theory… conclusions drawn from the Google case might not be applicable to other ideas, but I’d rather be studying a firm that has been successful than one that has not. There is a reason why the Patriots win and the Bills lose. What those reasons are could certainly be debated. But I don’t think it’s a logical debate on which team would be the better team to study if one desired to learn the innerworkings of a successful football program (and I’m actually a Bills fan, so I’m not sure what academics would say about this analogy!)

      As for Google as a stock, I didn’t render an opinion on whether the stock is currently undervalued. I’m not hesitant. But you’re right, I haven’t invested in Google for the same reason I decided not to in 2004. I’ve never invested in a number of companies that I admire. But I think it’s a worthwhile exercise to study and learn from companies that have achieved huge success in the past, in order to be prepared for future opportunities.

      As for your attributing Google’s success due to luck, or being in the right place, right time… I’m not so sure about that. Microsoft and Yahoo had far more resources and were in the same business as Google, but Google trounced them. Certainly, there is always an element of luck involved with many things in business and in life, but I think you’re short changing the talent and skill of management to just say that they won the lottery and just happened to find the magic formula to a company and that now produces $65 billion per year in revenue.

      Just some thoughts… no hard feelings regarding my disagreements.

      1. No doubt Google has management talent and long-term orientation, but it’s most likely not the reason for their success. Management talent is hindsight attribution and success dependent (i see a circular reference there!). But long-term orientation is a useful tool for prediction as you know it ex-ante and is not case dependent.

        You can definitely look at successful companies and see what makes them successful. But I have a hard time using the learnings in real life unless the data is robust. Study one successful example, the Spurs in your analogy, is not robust. If you have a few more teams with the same approach, then it’s useful.

        1. I agree with ‘an admirer’ on many points.I believe in many ways, in the world of business, it is being present in the right time that makes all the difference. Forget about the superiority of the product as such.

          First let me talk about traditional companies or companies that relied on classic sales and distribution. In hindsight, it always appears, Marketing played a very important role for these companies. But I’ll say it hasn’t(or not that much). It is being in the right time that made all the difference. Take Estee Lauder,for example. It started out when the baby booming America was becoming aspirational..when there was not much of organized cosmetics industry and so on. And it took off. Marketing is just a by-product. Since every product has a name, Marketing appears to have made the trick.But it didnot necessarily. Now try to create another Estee’ll be ultra-difficult. Same is the case with Larry Ellison’s Oracle(the late 70s:1977). He was simply at the right place,at the right time, when the market was simply ripe. I admire him enormously. But still..he sold a semi-working product and ruled the world. Of course, that is how business works. The point is: people underestimate the hidden role of timing in all these things. Even take Microsoft.

          Now coming to Google, agreeing with ‘an admirer’, who would have really bought it at 60 P/E, please tell me? Which investor could really have? I agree industry collisions are happening..but still. By that time, I guess even AdSense was not in place.And regarding the Master Card IPO given by AlphaSeeker(where it was worthy enough buying at an expensive P/E), I have a question: if the management itself were really sure about growth, why would they have left that much on the table? On that basis, normatively speaking, everyone IPO should be a unworthy, given the capitalistic elements of Human Nature.

          And I have some opinions(I may not be correct as well; correct me) about the success of Google. I do not attribute Google’s success to any PageRank or anything more than about just being lucky. I mean the algorithm was good, it did help it, but any other slightly good algorithm would have also done so equally well. It is also said that for some while, yahoo in some indirect way gave a lift to Google’s search somehow. In internet, you have virtuous circles embedded everywhere. Same I believe happened with Google than the algorithm per se. Do you not realize the process of links(a->b->c->…….->a sort of , so on) has many virtuous cycle like black-holes on the internet space. A very young, nascent, orphan website with no umbilical cord(read link) would find a hard time to enter that virtuous black-hole and in the mean time someone else could capture that space(and stay there given the network effects, switching costs, everything). Extrapolate this to the implications for marketing(think a general FMCG product or sth. like that). If you have 50mn.$, burn and burn and burn through Google, you’ll reach a virtuous cycle. Using that further burn and burn and burn.

          One last point: I’m capitalist and I’ll say capitalism manifests itself maximally in the online advertizing industry. I have a great conviction that advertizing in itself doesn’t offer competitive advantage for anyone(in the online world,more so), but poor guys, everyone still keeps spending and would continue to do so even if they come to know about this. Why? There is a Nash Equilibrium and that equilibrium favours “towards advt. spend” and not “let’s all stay put and stop”. Why? Because there are thousands of players and Game theory might say this is what would happen.

  3. What made Google successful was the paradigm shift of advertising from traditional mediums (magazine, newspaper, radio, TV) to internet. What the traditional mediums lacked was absolute market dominance. Not everyone is going to listen to the same radio show, the same TV channel or read the same newspaper. Turns out everyone (well USA, parts of Europe) overwhelmingly uses Google for their portal for the internet. What’s more is that Google can serve advertisements specifically on search queries thus making their product much more valuable than the shot gun approach of traditional media.

    This isn’t rationalizing, it’s just pointing out the facts if you understand the advertising business. I’ll admit I didn’t know jack about this business back in 2004 so I can let this opportunity pass without regret. Now the question is with this knowledge do I still ignore this?

    I’ll agree the author was a bit bias with the opening quote from Charlie Munger. What he left out was him saying “I have no idea what their business model will look 10 years from now”. That speaks volume about internet businesses, but I guess with Google’s cash pile they can buy up anyone that threatens them.

    1. Thanks for explaining why Google is successful. This makes sense in hindsight. But my point is you do not know whether Google will be successful at the outset. How do you explain Yahoo, Bing and numerous other search engines that “failed” to become a huge success? They also had the paradigm shift tailwind. Even if you understood the advertising business back in 2004, would you still pay 60x PE for Google then?

      If you were to analyze why a Food company was successful over the last 10 years, maybe I would believe the analysis as the industry is stable with no disruption. I would even use the learnings from the analysis for my future investments. But for a tech company, the analysis falls apart as it’s not robust. Predictions are too hard when you have a new product and potential disruption around…

      1. I agree that it’s hard to predict winners in a fast changing industry. This post was not designed to say “Buy Google because it has a moat”. I’m not suggesting buying Google (nor am I suggesting you shouldn’t look at it). I simply wanted to comment on a company that has experienced an incredibly successful decade. It’s up to readers to draw conclusions. I simply wanted to share some clips from the filing doc from 2004 I thought were interesting.

      2. Yes there were other competitors in the search engine sector, mainly Yahoo and Netscape. Google provided a stripped down user experience without the bloat. Bing was just late to the show and Google already had the industry locked down. Would it have been easy to pick Google as the winner back in the day? Maybe not, but spreading your bet on the industry worked out very well.

        As for the Earnings Multiple of 60x, this makes no sense since the industry was in its infancy. This is a different business from your standard businesses from the last 70 years. Walmart didn’t become the powerhouse they are overnight. It took them over 30 yrs to build out everything. With the internet, a company can reach full maturity within 7-10 years since the cost of adding another server rack is marginal at best. Google showed amazing ROIC at the offset and the cost of added growth was minimal. This creates for a powerful compounding machine.

        This just shows the human mind isn’t wired for grasping the concept of exponential growth. Sure I missed Google, but I was able to grab MasterCard when they IPO’d by applying the lessons I learned. The multiple was high, but growth came at very little cost for the company.

  4. I just want to say thanks to everybody here for the discussion! I found it very useful to just read different perspective.

  5. I agree with John here. Even though I’m generally skeptical of all the noise on Wall Street and believe it is largely efficient.

    Charlie is underestimating incentives, which is surprising. The network effect makes switching costs high for both customers and advertisers, and there is also a technology labor network effect where hiring all the best people is ridiculously expensive, so only the richest companies can afford to hire them, and the best people also migrate to the companies that are likely to win in the end. Thus, the business model is unlikely to change. You can actually use these network effects to find other good tech investments, for example, the number of good people working on Bitcoin far dwarfs its market cap, and it seems to have killed off all the alt-coins, so it’s likely a good investment.

    You could make a portfolio of very high network effect businesses (Bitcoin, Yandex, Baidu, Google, Facebook) and do quite well over time, especially if you dollar-cost averaged into the individual positions, bought them at reasonable valuations, or weighted more the latter 3 which have stronger network effects.

    I almost bought both Google (mid 2012) and Baidu (early 2013) but didn’t quite, and they both doubled from the point where I almost bought them. That wasn’t necessarily a mistake since the IRR on the rest of my portfolio has also been good but it does emphasize how fast the intrinsic value continues to grow.

    If I had to buy and hold something for 5 or more years I would be looking for companies like Google.

    1. Also I agree that the long-term thinking comment is super important!

      It’s often pretty straightforward to construct careers and/or investment bets that have a great ultimate outcome but a bunch of path-dependent noise in the middle. The noise or volatility, just isn’t meaningful. But most people focus on the noise. So they win a lot of unimportant battles and lose the war.

      In my career for example, I used to emotionally read bad things into my ability to do research, or good things, based on whether a project worked out, or I got a job, or not. Now I just say “you win some you lose some.”

      I just try to do things differently than others. What can I do that no one else can do? So I don’t have an career. And I try to find the fat pitches so I can hit some balls out of the park. My scientific research philosophy and investment philosophy are essentially identical.

        1. Recommended reading by W. Brian Arthur:

          Also of interest are the writings by Ray Kurzweil on accelerating change in technology (e.g. his book The Singularity is Near which I’m reading now). Much technology produces negative returns to investors (as discussed by Warren Buffett regarding aircraft companies). However, when there are sufficient network effects, it actually produces accelerating returns.

  6. Dear John,
    First congratulations on your excellant blog and excellant posts. Iam a regular reader of your blog.
    I largely agree with you on google especially with respect to point of moat(comptetetive advantage).
    I read somewhere that while analysing a business, warren buffett looks at situations where the moat of a business was attacked by the competeters and he often talks about mindshare.
    We should not forget that their cash cow is just really the search we should look at following imp. points
    1) Microsoft spent billions on bing and I dont think even bill gates uses bing.
    2) Yahoo have tried hard to catch up but they abondoned and now use bing.
    3) I have never seen anyone knowingly using any search engine other than google.
    Bing & others get most of their results when someone searches in bing/yahoo seach box installed as default on their browsers. So in the mind of web users web search mostly means google akin to any cola drink by default being coca-cola.
    Because of all this google has a monopoly in tersm of business and mindshare and it can increase its pricing easily. It has someother good moat business also like youtube & android os.
    I think for foresight on google, we would want to focus on following thinks.

    who else can attack google’s moat.
    1.a) Facebook would certainly try but from different angle of social search.
    2.b) More serious threat can come from AMAZON as its really very strong in analytics & bicertainly.
    3.c) Business of search moves from blind search to social search but I dont see it happening.

    Another thing is can we try to predict the fate of Facebook by looking at exemple of Google.
    I think facebook is at same inflection point as of google in 2004-2005.Lot of people think thet facebook has similar moat in social media as google has in search.Now I pose 2 questions to think
    1) would facebook be able to defend its moat in next ten years.
    2) would facebbok fade out as users want new cool things(snapchat & whatsapp etc.)

    For me there is another aspect which is necessity and usefulness. Necessity & usefulness gives more enduring moats than pure coolness. Think of pampers(p&g), pharma companies, nestle, J&J.
    Web Search mostly is necessity now so you dont look at the coolness of search engine. Social media is another game where coolness, trendiness etc. matter.

    Thanks, Piyush dwivedi

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