Internet Outsider: Why I Don't Own Google, Part 1

Several readers have asked what I think of Google's stock and why I don't own it. The focus of this forum is on the fundamental business performance of companies, rather than on stocks, so I haven't said much with regard to the latter.

Before I respond, let me explain a few things and also say again thanks for asking. Given the wholesale destruction of my reputation a few years back (please see this post and the disclosure statement I wrote in Slate for a summary), I am, as ever, grateful to even be asked such questions. Let me also remind everyone that, as a condition of my regulatory settlement, I cannot give investment advice. Because there is plenty I can say about stocks without providing investment advice, however, I will take a moment to spell out what this restriction entails.

The key distinction between investment advice and market punditry is the one-to-one relationship between an advisor and his or her clients. Investment advisors do not merely analyze and prognosticate about securities; rather, they study the specific circumstances of each investor client--goals, risk tolerance, existing portfolio, time-horizon, etc.--and then make recommendations tailored to the the needs of that client. A "buy" for one investor will always be a "sell" for another, and only an advisor can know the difference.

Most analysts and market commentators are not privvy to the circumstances of particular investors, and therefore do not actually provide investment advice, even though their commentary and opinions are often characterized as such. (Wall Street stock ratings, for example, are not investment advice: No analyst is in a position to know what every investor should or shouldn't do and no single action could ever be appropriate for all investors). This distinction is what allows CNBC, investment newsletters, the Wall Street Journal, Bloomberg, syndicated research services, stock blogs, and other publications to offer general opinions and advice about securities without being considered investment advisors.

In a forum like this (blog, magazine article, TV appearance, research service, etc.), I can offer opinions about stocks and even ratings, as long as the opinions are general rather than personalized in nature (an email exchange does not create a professional advisory relationship, but it is personalized, which is why I have to apologize in advance for not answering email queries about specific stocks). I haven't published ratings, though, and, for several reasons, I have no plans to.

First, although publishing ratings would be legally permissable, it would also--to me, anyway--feel inappropriate. The distinction between advice and commentary is not as obvious to lay observers as it is to lawyers, and I don't want to honor the letter of my settlement agreement while appearing to ignore the spirit of it.

Second, rating systems--no matter how carefully defined--are often misinterpreted. For example, when a stock is rated "buy" (or "outperform" or "1" or any other common term), analysts are usually said to be "recommending purchase" or "urging investors to buy." That they usually are not, in fact, doing this, but are instead just opining that the stock will go up a certain amount or outperform a particular benchmark (only one of many factors to consider when evaluating a purchase) is often lost in translation. And having already been carpet-bombed for this confusion, it scares the bejesus out of me.

Third--and here's the most interesting and, probably, annoying part--I believe the best investment strategy for most investors is not to buy and sell stocks at all, but simply to allocate assets to low-cost passive funds. I didn't use to believe this. When I worked on Wall Street, it seemed absurd to think that the massive amount of energy, brainpower, and money expended on buying "good" stocks and selling "bad" ones was usually wasted (or worse). In the years since leaving the business, however, I have examined the evidence, and I have been startled and disappointed to realize how conclusive it is.

The active vs. passive debate is complex, and one it tends to incite riotous responses on both sides. For now, therefore, I will simply say that the stock market is obviously not efficient if "efficient" is taken to mean that prices are always correct. (Prices are often patently incorrect: NASDAQ 5000 and NASDAQ 1200 cannot both be the correct present value of the same future cash flows.) The evidence, however, strongly suggests that prices are not so obviously incorrect that the mispricings can be consistently exploited to generate market-beating returns. I do believe that a handful of investors possess the talent, discipline, knowledge, and skill to beat the market, but only a handful. Most apparent investment skill, unfortunately, is simply luck--the random range of outcomes of decisions involving approximately 50/50 odds (stocks can only go up or down).

All of which is a long-winded way of saying that, although I obviously have opinions about stocks--and will occasionally share them in publications like this--I feel that publishing ratings would be encouraging an investment strategy (active trading) that I don't believe is appropriate for the majority of investors, especially small ones. It is nice to pretend that the investment playing field is level, but the idea that an amateur with Yahoo Finance can, in his or her spare time, compete with a full-time hedge fund professional with a $50 million research budget is, in most cases, ludicrous.

For those who know all this, are trading for fun, or make stock-picking decisions for a living, this position will sound like a cop-out, and I'm sorry about that. My hope is that the business analysis alone will be interesting, and I promise to stick my neck out and make concrete (and embarrassing) predictions in this realm.

So...the first reason I don't own Google is that I invest mostly in index funds. To indulge my prior habits--and to put my money where my long-term conviction is--I do have long-term positions in a few Internet stocks, but I view this more as entertainment than as a serious attempt to beat the market. If I see an opportunity where my conviction level is high, I might make another investment or two, but I'm not actively looking. And for reasons I'll explain in the next post on this topic, Google would not clear this hurdle today.

I wrote a series for Slate last year called The Complete Guide to Wall Street Self-Defense, in which I discussed many of these issues at length. For those interested in the passive vs. active debate, I would recommend David Swensen's recent book, Unconventional Success (pictured above), as well as anything by John Bogle, Charles Ellis, Larry Swedroe, and others. An investment advisory firm called Index Fund Advisors has built an exceptional web site aggregating most of the academic and journalistic work on this topic and offers a "twelve-step" plan designed to help investors kick the trading habit (full disclosure: IFA's president invited me to speak at a conference earlier this year; I did not receive a fee, but I was reimbursed for travel, hotel, and meals).

Comments

You don't invest in Google wow, Obviously you are not making any money. I made enough money on Google to compinsate me for the Huge losses I has from World Com remember that dozzy one.

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Posted by: Jeremy Campbell | December 01, 2005 at 07:18 PM