After reading the title, you probably already think that I am crazy, but before you make any further judgments consider my argument that Google may in fact be the unfortunate ruler you heard about as a kid. For those of you unfamiliar with the tale I am referring to, the heart of the story is that the Emperor’s tailors dupe him into believing they make fine garments that can only been seen by the wise. In reality, the clothes are merely an illusion and the Emperor is indeed naked, but nobody is willing to say so. Is this an outlandish analogy to make with GOOG? I think there are several valid comparisons that can be drawn.

The first point I want to make is that Google is a great company, and they do an excellent job in their business space. The numbers are convincing, as Google dominates internet search with around 54% of the searches in the United States this past March and receives 25% of all online advertising dollars, the highest share of any one company. Yahoo is a distant second with 18% of the market. Further, Google is expected to grow their share of internet search marketing to 30% this year.

It is not hard to see how Google is making all of this money with their dominance in AdWords and AdSense, but while Google is a great company it is also important to remember that the best company does not always have the best stocks; as it can easily become overpriced. This was evident in 2000 with Microsoft and many other leading companies - they were simply too expensive. I believe if you were to take Google’s financial statements, strip them of the “Google” name, and give these numbers to any analyst they would tell you that the company is not worth over $150 billion. While analysts are using various EBITDA multiples and forward P/E ratios to price GOOG, looking at the Statement of Cash Flow and comparing that with the estimated growth rates makes it appear that GOOG is significantly overvalued. While I understand that Google does a lot of things better then many other companies (cough, Yahoo), when you buy Google you are paying a huge premium - more than I think is deserved.

How does this relate to the Emperor not wearing any clothes? In the story, everyone is told that the cloth had the special capability that it was invisible to anyone who was either stupid or not fit for his position. It takes a small child to finally proclaim that the Emperor was naked because everyone else was afraid to go against the crowd. I feel that analysts are shrouding Google stock in that cloth and being overly optimistic about anything that happens with the company, and even those analysts who aren’t truly optimistic are afraid of calling out the truth about the Emperor. I recently read an article in which the the author stated he was unable to find an analyst covering Google that had less that a “hold” rating on the stock - by our count, 27 brokers have a rating on GOOG, and this uniformity of opinion is scary. I find this crazy when looking at the valuation of Google given it is trading at such a high FCF multiple even net of cash on the balance sheet (72x EV/FCF), as the amount of growth needed to justify the current price is well above just about any analyst estimate.

So, I am going to be the proverbial little kid and say I think GOOG is overpriced. While I do understand that Google is a great company, I think the premium put on Google is far too high. I personally would advise against buying GOOG, but if you feel compelled to buy I would advise hedging the downside risk through options, as I see no margin of safety in the stock.