THE GOOGLE OF MY EYE

Buy GOOG.  After reviewing the recent earnings conference call transcript and financial statements I think it’s time to start paying attention to the stock as a technology sector or media industry-related GARP investment.

In a word Google has chutzpah, but it ain’t bragging if you can back it up, right?  From the beginning the internet search pioneer gave Wall Street the proverbial finger by using a Dutch auction for its 2004 IPO. Ultimately, the actual mechanics of that deal were slightly modified that enabled an otherwise impossible (theoretically) first day pop, but they still sent a clear message by giving the investment bankers at Goldman Sachs (GS) the shaft.

However, any stock capable of rising above $700 from $85 within 3.5 years is quickly forgiven. Even after the spectacular collapse of the Tech Bubble indelibly seared into every investor’s memory, we still saw analysts leaning on bespoke valuation methods versus traditional cash flow to justify GOOG’s ascent. Analysts may know deep down in their hearts geometric growth rates are unsustainable, but few are incentivized to be the party pooper. Besides, why fight the rising tide of a stock that is the favorite of retail investors, traders, growth managers, and above all, freshly-minted Ivy League MBA’s? 

Retail can be forgiven for being brainwashed that buy-and-hold is a robust strategy, and is the surest way to achieve early retirement if you can just hit that one grand slam stock; GOOG’s prospects were obviously peerless, right?Traders are just renting the stock and following the action. The smarter ones at least seek some insight from bona fide tech geeks online (they would not be found amongst their circle of friends, of course), and the brightest of the lot may even be capable of constructing some plausible industry comparisons. Meanwhile, PM’s of growth funds, in my view, are the true pioneers of behavioral finance since they utilize an awareness of the above, and the existence of other growth-style managers, to employ the greater fool theory. And lastly (sadly?), the prototypical MBA suffers from all of the above afflictions to some degree. There is a reason why someone has already created the contrarian “Harvard MBA" indicator. And it was even invented by an alum. 

Getting Back to Basics.  While playing hard to get may be a good tactic for a beautiful young woman with many suitors, it’s not a sustainable strategy to find true love. It would seem that GOOG has finally matured into young adulthood. Namely, the company is finally forthright that its business is not recession-proof. Cost control has been a major issue since the stock started to tumble over a year ago, and now there is finally some concrete evidence that a quaint metric like operating margin is foremost in the mind of management. Measuring performance of continuing operations by this metric sure comes in handy when you announce a gigantic investment write-down (or two).

On the subject of management, it was also announced in the earnings call that “Larry and Sergei” will no longer be a featured every quarter. Good. If they ever want to convince the world that CEO Eric Schmidt has a meaningful role beyond a figurehead the engineers need to be off the call. More importantly, the tacit suggestion that the founders are going to be sticking to “engineering” suggests GOOG's deal-making track record has a chance of improvement. Who can be impressed by the major deals done so far in the equity investments of AOL and Clearwire, or acquisitions of YouTube and DoubleClick? To wit, the easiest way to gain a small fortune is by starting with a large one.

The Real Economic Moat.  Instead I much rather see the company continue to preserve its reputation as a great place to work for the best engineering talent available. Its human capital is the true wealth creating engine, maybe more so than financial firms, if it can maintain its entrepreneurial culture. If offering the options exchange program was deemed to be the most effective way to bolster employee morale than so be it; it’s not shareholder friendly per se, but the intangible benefits should be the payback down the road when the market for its most valuable employees opens up more broadly again. At worst, it enhances its budding alumni culture that highly respected firms in other industries like Goldman and McKinsey flog however they can. I also object to the Silicon Valley truism that publicly traded Internet companies can only “lead” for four years. In this case, the recession/low-growth economic climate, which I believe will persist for a long time, should insulate GOOG's incumbency, especially as MSFT, YHOO, EBAY, IACI, NWS, et al. fumble about. 

MHP Pair Trade.  When market conditions are this challenging, however, I still favor a market-neutral strategy. Shorting an old media stock such as McGraw-Hill (MHP) to offset long exposure to GOOG would be my recommendation. MHP not only has a stable of magazines, but also owns a market leading bond rating agency franchise, Standard & Poors. This is hardly breaking news, but it doesn’t seem plausible that S&P’s business, along with Moody’s (MCO), not become potentially crippled by conflict of interest reform pursued by the Obama administration. I would short MHP now, but save some some buying powder on GOOG in case it pulls back to $280-300 amidst a general market selloff; GOOG is susceptible to be hurt as an easy source of fund-raising.

Disclosure: No positions.

FLYING HIGH - Airlines (LCC), PALM, Not: AAPL, JPM

Late this afternoon an emergency landing by a US Airways (LCC) flight from NY (LGA) to NC (CLT) in the Hudson River was executed to perfection upon engine failure (flock of birds). As accidents go, the circumstances could not have been more ideal as the pilot adroitly landed the plane intact and a slew of commuter ferries readying for the PM rush were immediately available to assist in the rescue. Apparently everybody got off the plane safely. The ultimate cost to the company not covered by insurance should be de minimus. The positive PR boost ($1-3 MMs?), on the other hand, probably more than offset said cash cost. What a great story to bump Mad-off from the news (re)cycle. My hat's off to responders.

Source: CNN.com, Inset: Pilot Chelsey B. "Sully" Sullenberger

The immediate investment implication for the airline sector at-large, and LCC in particular, would seem to be very positive as investors have an incentive to check-in on the industry. Many are in the Warren Buffett camp of forsaking the sector altogether, but I consider George Soros a better role model as he embraces the roles of investor, trader, or speculator as context dictates; he was an original investor in JetBlue. Therefore, it seems timely to reiterate my strong intermediate-term support for buying the airlines (as long as the overall market isn’t tanking).

The story is straightforward for the “bad” airlines (e.g. not LUV). The companies coming out of bankruptcy over the last few years face what appears to be a minimal threat of labor strife and have been manic about controlling costs ex-fuel; capital restructuring (less debt) opens the door for consolidation; and the gigantic headwind of last year’s jet fuel costs are going to drop off the cliff in 2H09 as hedges expire. Further, the airlines have pricing power right now as the industry can cut suppoly at a rate on par with the fall in demand. Passengers may sometimes find it more economical to ship luggage ahead via UPS, but people still have to put up with the a la carte pricing schemes as seat capacity is limited. Also, first/business-class is being filled by full fare customers (except morons like Stephon Marbury) that were previously flying chartered jets, which crowds out the “upgrade” crowd; massive airline mile deflation also support margins. If only OPEC could be so successful.

If you care to geek out on the analysis further consider a visit to this analyst/ex-pilot’s site.

PALM. Being long a high-beta, heavily shorted name in the midst of a terrible market was no fun on WED especially since the stock closed below the post-CES pop from last FRI. Not good, but being a slave to technical analysis on a fundamental idea isn’t my style and I didn’t panic; it’s the wrong move when a company reaches an inflection point. Today’s +35% move was a sweet confidence boost, but taking profits now would be too early. Data from ShortSqueeze.com indicates that 38% of the float is short (12.7 days relative to average daily volume), and you can bet more was added amidst the high volume yesterday. The whipsaw bounce today accelerated into the close so I can virtually guarantee that the stock gaps up tomorrow. At $8.50/sh I would sell at least 1/2 the position. Place the limit order now, because PALM may hit that tomorrow.

AAPL. Acted well despite my screed yesterday, but this company needs to join the world of dividend-players. Growth stocks with decelerating growth rates are “value traps.” This goes for GOOG as well, who just axed 100 people from HR.

JPM. Opening above yesterday’s close was a “win” on my preview prediction, but I would have sold all trading longs at the open today. C is rumored to be promoting the bad/good bank idea. The last prominent company to do so was Lehman Brothers; I’m just saying. Financials remain firmly in day-trading territory at least until Treasury/FED hammers out a more definitive game plan. Bernanke suggested revisiting TARP on Tuesday, which is fine with me, but let’s see what happens in Congress.

INTC. After pre-announcing results twice this Q, they managed to "meet" consensus EPS of $0.04. If things are that bad for INTC think just how much worse the outlooks are for NVDA & AMD.

Disclosures: Long PALM.