Just when you thought the world had its hands full with Iran and Iraq, another maverick country, 7,000 miles to the east, has jumped into the fray: Venezuela.
President Hugo Chavez is expelling a U.S. Navy officer for allegedly passing secret information from the Venezuelan military to the Pentagon.
The United States, for its part, has responded quickly, expelling the chief of staff of Venezuela’s ambassador to the U.S.
This is serious. And much like the looming showdown with Iran I told you about yesterday, it’s escalating.
Yesterday, Hugo Chavez accused the U.S. of committing “an act of political retaliation.” And in the next round …
Chavez Warns He Will Fire
Back with the Oil Weapon
If the U.S. cuts off diplomatic relations, a likely step in the escalating diplomatic war, Chavez will …
- Shut down his government’s U.S.-based refineries …
- Sell all his oil to everyone else except the United States, and …
- Set off a whole new chain reaction of events that could escalate into a full-scale trade war over oil.
Chavez isn’t playing around with subtle hints. His intent to drive up oil prices is actually very explicit:
“We’ll see how high oil prices go,” he said in a recent rally. “We’ll see how much a gallon of gas will cost. I could easily sell the oil we sell to the United States to other countries.”
Will Chavez actually do this? Or is it just rhetoric? We don’t know. He himself probably doesn’t know. But if he puts action behind his words,
Chavez Could Leave the United States
Between a Rock and a Hard Place
This is an intolerable situation.
Washington can’t let appropriate diplomatic responses be at the mercy of a dictator’s threats against our oil industry and our economy.
And, at the same time …
Wall Street and Main Street can’t afford to get cut off precisely when they need the oil the most.
But if push comes to shove, Chavez will leave us with only one choice: To take a tough line … to cut off relations … and let the stronger economy win!
Ultimately, the United States will prevail, but at a price a very high price.
Reason: Venezuela is no small fish in a sea of oil producers. It’s the world’s fifth largest. It supplies the United States with 15% of its needs. Its state oil firm operates refineries and gas stations right here in the United States, under the Citgo brand.
A Painful Prospect
I was brought up in South America.
The last thing I want to see is the two continents at each other’s throats. But I must face the reality that I’ve been trying to avoid: A tit-for-tat diplomatic and economic war is now in the cards.
The impact on the United States: Potentially as big as any crisis now boiling up in the Middle East.
Your action: Hold on tight to your energy investments. And if you have funds available for more aggressive plays, jump in on Larry’s new high-powered recommendations going out tomorrow. Number to call: 877-719-3477. Deadline to join: Tonight at midnight.
Google Fish Story
by Tony Sagami
January was a great month for the bulls, but February is off to a very rocky start.
In the first four trading days of February, the Dow Jones, Russell 200, and S&P 500 have lost from 1% to 1.3% of their value.
Tech stocks, however, got spanked much, much harder. FACT: The Nasdaq 100 has fallen by more than double the percentage as the other indexes.
Should that spanking concern investors in tech stocks or tech-heavy mutual funds?
If you’ve been a reader of Money and Markets for a while, you know my answer: Most tech stocks are extremely overvalued and vulnerable. But don’t just take my word for it. Look at what’s happening to the company that was, until now, the most spectacular tech story in the world: Google.
Why Google Missed Its $1.76 Per Share by a Mile.
Why It’s Really Earning Only $1.22 Per Share!
Google floated its IPO back in August 2004 at $85, the start of an extreme and extended run that sent the stock as high as $475 by mid-January.
At $400 a share, Google had created four billionaires, including founders Sergey Brin and Larry Page, worth $16 billion apiece. Meanwhile, one in five Google employees is estimated to be a multi-millionaire.
Google became a $130 billion company and was selling for 100 times forward earnings. People said Google’s glitter and glamour was like a beacon for the revival of the entire tech industry.
Then Google reported its Q4 results last week $1.54 per share or a full 22 cents below Wall Street’s far rosier forecast of $1.76 per share. In the immediate aftermath of that news, Google dropped as much as $56. Almost $16 billion of market value was wiped out.
Why such a sudden plunge in the stock?
Because when you have a stock that’s trading for 100 times earnings, there is not much room for error let alone for a huge, 22-cent shortfall.
And why such a big earnings miss?
If you ask Google, it was simply because of an unexpected increase in foreign sales, which are taxed at a higher rate. Google expected to get hit for a 30% tax in 2005 but instead ended up paying 31.6%.
What?
I don’t know how big of an army of bookkeepers, accountants, CPAs, and tax experts Google has on its payroll, but I’m sure they’re not exactly understaffed.
And Google wants us to believe that, in spite of their army of number crunchers, they were completely caught off guard with a higher tax bill?
Even if you believe Google’s fish story, the fact is that the higher tax bill only accounted for 11 cents of the 22-cent shortfall.
Look at the math:
1. Google reported about $2.14 billion in pretax profit in 2005. So if you apply the 30% tax rate that Google thought it was going to pay, you’d get a tax bill of $642.6 million.
2. The actual amount of tax that Google paid was $676.3 million, or an additional $33.7 million beyond its earlier estimates.
3. With 304 million shares outstanding, that comes to only about 11 cents a share. Plus …
Here Are Some Other Fishy
Details in the Fine Print …
Fishy Detail #1: Google’s gross operating income dropped from 33.5% of gross revenues in Q3 of 2005 to 29.7% in Q4. In other words, the expense side of the income statement is growing faster than the revenue side.
Specifically, Google spent more on capital spending, and overhead costs rose more than they anticipated.
Their excuse: We are scaling this business rapidly and we are investing for the long term.
My view: This is a company that’s beginning to reach the bloated, bureaucratic stage. But Wall Street doesn’t get it, at least not yet.
Fishy Detail #2: The insiders are selling, and selling a lot.
CEO Eric Schmidt sold $345 million of Google stock in 2005. Plus, coincidentally, he sold 56,000 shares last Monday, a day before Google coughed up its profit hairball … and another 61,000 shares on January 26.
But Schmidt isn’t the only insider selling like crazy. He and 13 others, including founders Page, Brin, and CFO George Reyes sold a total of $4.3 billion in stock in 2005.
I don’t blame the Google big wheels for cashing in on some of their stock. After all, French chateaus, Ferraris, and Lear jets don’t come cheap. But $4.3 billion is an awful lot of dough for such a short period of time.
Fishy Detail #3: Google already dominates the U.S. market. So its best shot at growing at a juggernaut pace is to extend its dominance all over the globe. Already, $735 million of Google’s $1.919 billion in gross revenue came from international sources.
The big problem: Google’s overseas business isn’t growing. In fact, it is shrinking. Google’s percentage of revenues from foreign sources dropped from 39% in the third quarter of 2005 to 38% in Q4.
Trouble is, this doesn’t jive with Google’s higher tax excuse. Remember, the reason Google said it got bushwhacked by a higher-than-expected tax rate was because of a higher foreign rate.
Fishy Detail #4: At $430, Google was essentially priced as if it were going to grow its sales by 30% each quarter and by 108% annually, year after year.
So guess how far the Jack-and-the-Beanstalk crowd was off!
Google grew its sales (excluding traffic acquisition costs) by 23% quarterly. That’s good, but nowhere near good enough to satisfy the Google-onians.
Fishy Detail #5: Google is still one of the last holdouts (including Intel) that have yet to start recognizing the cost of their stock options.
Nearly everyone now admits that stock options are really a form of compensation to employees, much like wages and benefits. But at Google, they’re not.
Result: The barnyard pro-forma numbers that Google uses grossly overstate its actual results.
How bad is it? The Motley Fool reports that, if Google were counting the cost of stock options and not adjusting for a donation to the Google Foundation, its Q4 earnings would have been about $1.22 per share. That’s a far, far cry from the $1.54 Google said it earned.
I Love Google, the Search Engine.
I Don’t Love Google, the Stock.
Don’t get me wrong.
I’m a big Google fan. In fact, I probably use Google’s search engine at least a couple dozens times a day.
But Google is now beginning to face a very familiar problem the same one that has plagued many tech companies in this decade:
Google started out as a technology leader by offering the best, the fastest, and the most accurate search engine in the world.
But the computer algorithms at the heart of Google’s success are nothing that any other company with an army of engineers, programmers, and mathematicians couldn’t duplicate with time.
Result: Rivals like Yahoo and Microsoft have improved their own search engines to the point that Google has little if any technological advantage over them.
Soon Google will no longer be a company based primarily on cutting edge technology. Rather, it is in the process of becoming a company that’s based mostly on a well-known, popular brand name a brand name like Head & Shoulders shampoo, a Schick razor, or Bayer aspirin.
There’s nothing wrong with that. And Google will try to offset its waning leadership by expanding into other areas. Trouble is, at 100 times forward earnings, Wall Street isn’t factoring in this maturing phase in Google’s life cycle.
And the metamorphosis from whiz-bang tech kingpin to a popular-but-common service provider could be deadly for Google investors.
A Very Bad Bet
Look. Anybody who buys Google today is betting that Google will be able to maintain its quasi-monopoly on search and Internet advertising far, far into the future. In other words, the Google-onians are betting that there is no such thing as the next Google.
Unless Google is immune to the laws of technological change, that’s a very bad bet.
And don’t think that, just because you don’t own Google shares, you don’t have a dog in this hunt. Some of the most popular and widely held mutual funds own millions of Google shares.
Take the Growth Fund of America, for example. With its 8.1 million shares, it owns more Google than anybody.
Or consider Fidelity Discovery, Fidelity Growth Company, and Fidelity Magellan, which hold 10.6 million shares collectively.
Legg Mason Value? Another 2.1 million shares!
Bottom line: Google is certainly cheaper today than it was a week ago. But that doesn’t make it a bargain. Quite to the contrary, even after last week’s dip, I think it’s one of the most dangerous tech stocks in the market today.
Connecting the Dots
So there you have it:
- The Nasdaq leading the stock market down in the first days of February, and simultaneously …
- The shocking news from Google, which is actually a lot worse than originally announced.
A coincidence? Far from it! Google was the great big kingpin of the Nasdaq last year. So when it goes down, so does the Nasdaq.
Moreover, Google isn’t the only tech company suffering from overvaluation and wild-eyed Wall Street expectations. There are plenty of other yet-to-be-reported disappointments waiting to take the Nasdaq lower.
Just last week, for example, a fistful of software and hardware companies warned Wall Street analysts to tone down their 2006 expectations …
Software warners: Symantec, Business Objects, Checkpoint, Parametric Technology, and Hyperion.
Hardware warners: Apple, Motorola, Intel, and Texas Instruments.
Amazon.com also rained on the tech parade. Its stock got clocked for 10% after it reported a 43% plunge in Q4 profits on Friday.
Even with the generous tail wind from holiday shopping, Amazon’s Q4 sales were $100 million below expectations $2.98 billion instead of $3.08 billion.
On a year-over-year basis, Amazon saw its shipments increase by 22%. That may sound good. But it’s also the slowest growth in Amazon’s history.
As with Google, the Wall Street crowd has yet to figure out that, although Amazon is growing, it’s not doing it fast enough to justify its share price.
Investing in Tech Stocks Right Now
Is Like Walking Through a Mine Field.
If you know where the land mines are buried, you have a chance to make money. If you don’t, though, your chances are very poor.
For starters, I would avoid:
- Companies making tech products that have been reduced to cheap commodities. Examples: DRAM chips (Micron), flash memory chips (SanDisk), and PCs (Dell or Gateway).
- Hardware and software companies that cater to the enterprise or corporate market. Cisco, Nortel, IBM, Siebel Systems, BEA Software, and Oracle.
- Internet retailers. Like Amazon, eBay, Yahoo, and Overstock.com
I’m not 100% sure I know where all the land mines are. But I’m pretty confident I know where most of them are not. They’re …
- The leading innovators in electronic doodads
- Internet security providers, and
- Asian tech stocks selling for much cheaper multiples.
The moral of the story:
1. Be very selective. That means no Nasdaq index funds and no big, diversified mutual funds that have a little bit of everything.
2. Be very cautious. Keep plenty of cash on hand. Don’t overinvest in anything, let alone tech.
3. Ride the big wave. I’m talking about the amazing surge in oil, gold and natural resources. I know of no one who’s on top of it like Larry with his Real Wealth Report. Stick with him.
Best wishes,
Tony Sagami
About MONEY AND MARKETS
MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Beth Cain, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.
2006 by Weiss Research, Inc. All rights reserved.
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