Google cant Foundem

A recent lawsuit against Google questions the legitimacy of its blockbuster algorithm that ranks search results, and whether there is any human intervention at all in how results are displayed. There are suggestions that Google has, and uses, a system to penalize or blacklist certain sites, which are then relegated beyond the 3rd or 4th page, thus drying up virtually all traffic. When such sites happen to be search engines themselves, things get murkier. The recent accusation of Foundem may be an isolated incident, but there are certain developments that do appear ominous.

Google's innocuous Universal Search that not only returns websites based on search phrases, but also retrieves relevant images, maps, blogs etc., may have put websites such as labnol or mapquest out of business. When searching for a city or town, I remember Google showing links to Mapquest and yahoo maps, but not anymore. The feature is definitely convenient to the user, in the same manner that bundling Internet Explorer free with Windows was.

Players like Google and Apple have been making noises forever about Microsoft's unfair practices, but some of their own actions are disturbingly similar. I cant recall the last time I typed a URL in my address bar directly. Even when I know the URL, it's easier to google half the website name and click through to the website. Thats laziness, of course, but it also shows my trust in Google - that it will fetch me what I am looking for, and usually as the first result. I doubt if I am alone in reposing complete trust in Google. So when more than three-quarters of the world uses Google to search, the results displayed can potentially influence people's actions, including purchase decisions, which means money. And there's the rub. With iPods having the insane marketshare that they do, and their ability to communicate only with iTunes, what is available for purchase, and prominently displayed, on iTunes can affect purchases. Apple's recent decision to take down inappropriate software from its iPhone app store is another example. Amazon can drive or kill book sales simply by adding or deleting a "keyword" to the book description.

This is not a new phenomenon limited to websites. This is true of large players in other industries, and is akin to what Toyota is going through. In an open economy, you are allowed to make defective and dubious products. Its not a crime; customers will simply dump you and switch for better ones. But once you establish certain quality standards and gain customer trust, you automatically take on the responsibility to maintain that. The GEs, Boeings and Cokes of the world cant make the kind of mistakes that a mom-and-pop business can. It may seem unfair, but as the saying goes, with great power comes great responsibility.

MS Yahoo deal - Yahoo RIP

MS and Yahoo have entered into a deal to beat Google. While the details are not completely clear to me,  it seems like MS will essentially use the Bing architecture to power Yahoo searches. Consequently, the two cos will end up sharing revenues with Yahoo retaining ~90%.

Lets see how this will play out. Everytime you search for something on Yahoo, it is actually Bing that does the search and delivers the results. Now, search-based advertising means that ads will be automatically displayed based on search strings. So that will be done by Bing too. And of the revenues earned, Yahoo pays 10% to MS.

The only thing Yahoo had going for it is the #2 position in search and the resultant reveues from ads. That advantage is now erased 'coz it will depend on Bing to make money. I doubt if the agreement will restrict MS from competing in the ad space. So now MS gets to make its own ad money and also get money thru ads on Yahoo (although only a small %). But thats not the point.

The point is MS gets a much larger canvas to play on. The Bing "search system" will be used at least 4 times more than if Bing remained a standalone search engine. And all this data is available to MS, which means it can make Bing that much better. And once Bing starts getting better, and word spreads that Yahoo is actually "Bing", surfers like you and me will start searching on Bing directly rather than Yahoo (Some will go to Google, but hey, if they are still on Yahoo, they are probably gonna end up with Bing than Google). Consequently, Bing's market share will improve at the cost of Yahoo's, resulting in movement of customers from Yahoo to MS. Once Bing reaches a critical mass in the next 3-4 years, say 25% market share (standalone), it may damn well pull the plug on the deal.  In all probability, Yahoo would have stopped work on its search platform and would be left stranded. Meaning all remaining Yahoo customers will drift to MS or Google.

My feeling is MS couldnt have asked for a better deal - it gets to kill Yahoo, although not immediately, but hey, they dont have to pay a penny. Well for Yahoo, it is definitely suicide.

Value of a Stock – Part I

For a financial layman, like I was a year ago, the price of a stock is a mystery. Why does Microsoft trade at $25 whereas Google trades at $450? And why do analysts mean when they say Google is cheap at $450? Isn't MS dirt cheap at $25 then?

That's the first rule. The price by itself doesn't tell you anything. What you need to know is the price of a stock relative to its value – another term relentlessly abused by the financial press and analysts. Let me try and debunk this mystery.

Buying a stock is an investment so you expect some returns. Think of a bank term deposit. Let's say, you put in $1000 for a year, the bank pays you some interest. The interest is your return from the deposit. Of course, the big difference between the two is that the returns of a stock are not well-defined. Let's dig deeper.

If you hold a stock, your return can either be capital gains or dividends. Capital gains are simply the profits you make when you sell the stock at a price higher than what you paid to purchase it. For example, if you buy MS at $25 and sell at $40, your capital gains are $15. Dividends are cash payments made to you by the company at regular intervals, usually annually or quarterly. For example, MS recently announced a quarterly dividend of $0.13 per share.

Now that we know the types of returns, the big question is, how do you know if a stock will deliver any returns? And are those returns good enough? Let me answer the second question first. Your stock has to at least beat the 5% APR offered by your bank, if not, what's the point? Might as well invest your money in bank deposits and sleep in peace. But, are you happy if the stock returns exactly 5%? No, because you are taking on an appreciably higher risk by investing in the market. When you take that kind of a risk, you expect to get rewarded. So the return from a stock has to be definitely higher than your bank rate. But, how much higher?

For a moment, let's set our stock aside and take the stock market as a whole (or simply the "market'). The market is represented by indexes such as Dow Jones, NASDAQ and S&P 500 – there are many more, but these are the popular ones. These indexes are comprised of multiple stocks from various industries. So you will have stocks from FMCG, tech, telecom, infrastructure etc. Some of these cos will be good, some bad, some growing and some declining. Let's say you want to invest your money in the "market" - in other words, think that you are buying 1 stock of the S&P 500 index. What should be your return? There are ways to derive this, but the simplest way is to look at the returns delivered by S&P 500 in the past. Take the year-end values of S&P 500 over the past 30 years, find out the annual return (annual growth, to put it crudely). Now, determine the difference between the S&P return and your bank rate. This delta is called the Market Risk Premium, which is the additional return you are expecting because you took the additional risk of investing in the stock market rather than the safer term deposit.

But remember that the stock market has many companies so the negative effects of some stocks are offset by the positive effects of others. For every Sun that fails, there is an Apple or a Google that delivers stellar performance. So the risk of investing in the "market" is different from that of buying a specific stock. Some stocks are safer than the market and others are riskier. For example, P&G has been making hair and body care products since forever. And unless we dramatically change our ways of personal hygiene, it is fair to assume that P&G will continue to sell its products. So, it is a safer bet. Contrast it with Google, which is threatening MS and Apple today, but could just as easily be threatened by Facebook or MySpace. Therefore, Google is riskier than the market.

To determine the relative risk of a stock versus the market, analysts use a term called Beta. Without getting into the details, it is a factor to arrive at the risk premium for your stock, which is a product of your stock's beta and the Market Risk Premium. (By the way, the Beta of the market is 1.) Beta for cos such as Google will be >1, and that of Unilever etc is <1. Now add this to your bank rate to find out the return you must get from the stock. Let's take an example.

Say, annual returns of S&P over last 30 years is 8%

Beta of Google is 1.17

Your bank deposit rate is 5% (Technically, this should be the rate on US treasury bonds, but this is a fair approximation.)

Therefore, Market Risk Premium (MRP) = 8% - 5% = 3%

Risk premium for Google = Beta * MRP = 1.17 * 3% = 3.51%

So expected return for Google = 5% + 3.51% = 8.51%

In other words, Google is an attractive stock, if and only if, it offers returns above 8.51%. The next part will discuss how to determine this.

To be continued…