Jeremy Warner's Outlook: Dot.com Mark 2: Google sets its sights on domination, yet still the shares are mispriced

Oil: a case of peaking too early; Tesco still leads, so why the discount?
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The Independent Online

Not content with taking an ever greater share of the advertising market, Google seems intent on taking over the advertising industry too, or rather, becoming a substitute for it. Yesterday's acquisition by Google of dMarc Broadcasting Inc, a technology that allows advertisers to bypass traditional agencies and media buyers to place their ads directly with the most appropriate digital radio stations, is another straw in the wind. Similar technologies are being developed for TV.

The costs of producing video and buying airtime are too big for most small businesses. New services being developed by Google and others, in combination with digital fragmentation of audiences into a myriad of different channels, make TV advertising accessible to smaller companies for the first time. dMarc and its like are as big a threat to traditional advertising firms as Google is to other forms of "old media".

All this helps explain why Google, still less than 10 years old, is today worth the thick end of $100bn, a multiple of sales and earnings that makes even the wildest fancies of the dot.com bubble look conservative. Google is changing the world, of that there is no doubt, though it seems to me rather unlikely it is making it "a better place", the company's mission statement. Few industries have been left completely untouched, and some are being decimated by it. Yet "search" is still an embryonic business, and although Google's lead may seem unassailable, it's not going to look that way for long. Google itself was quite late into the the search game, but it didn't take long to trounce more established rivals.

A whole range of smarter technologies, not exclusive to Google, are already up and running, from "implicit query" search, which anticipates and hones inquiries from key words, to "smart folders", which automatically accumulate material of interest to the user. All these are likely eventually to pose a considerable challenge to Google.

As such, the stock is almost certainly mispriced. I can't tell you when it will come back to earth. It may well double or triple again before it does. Yet anything that discounts more than five years into the future is doomed to disappoint, especially in a business as fast-changing as this one.

Oil: a case of peaking too early

Another day, another dollar. Up another 100 cents at one stage yesterday, the oil price is heading back towards record territory. The immediate cause is mounting tension between the West and Iran - the world's fourth-largest producer - and rebel attacks on oil installations in Nigeria. Yet as our news analysis opposite reports, the underlying causes are more structural than geo-political.

For years, geologists and economists have worried about what happens when the oil starts to run out. We can safely assume that even with burgeoning world demand, this isn't going to happen any time soon, yet "peak oil", where production stops increasing and goes into inexorable decline, may be nearer than we think.

There are no certain answers to this question. Everyone's got an opinion, some better informed than others, but on the whole, the economists tend to be more optimistic than the geologists. The latter point to the fact that of around 100 countries with known oil reserves, some 60, from the UK to the US, are already past their peak. Whatever the reserves of the others, at the current rate of consumption, they are bound to reach that point quite quickly too.

The integration of China, India and other emerging market economies into the world trading system has transformed worldwide supply and demand in more or less everything, but in particular in oil. Over the last decade, net imports of oil to China have risen sevenfold. Previous spikes in the oil price have tended to be driven by temporary supply constraints; this one is driven by fast-growing sources of new demand.

In theory, supply should expand to meet this demand, particularly if the oil price is high, making previously uneconomic reserves a bankable proposition. The single biggest example of this is the great tar sands of Canada. The oil is expensive to extract, but virtually unlimited. If the oil price were to rise to and stay at $100 a barrel, they would be well worth exploiting, ensuring peak oil isn't reached for many years.

The other effect of high oil prices is to depress demand. This works in two ways. Firstly, it provides an incentive to use less oil and to find alternative sources of energy. Secondly, high oil prices depress economic activity more generally. More spent on oil means less for other things, which reduces consumption, economic activity and eventually use of oil.

This is why Opec, after the disasters of the 1970s, was so keen to keep the price within bounds. If it rises too high, the taps are turned up to bring it down, and if it falls too low, production is decreased to bring it back up again. The last thing Opec wants to happen is for the price to rise so high it tips the world into recession, for then both demand and prices collapse.

These old paradigms seem to have been shattered by recent experience. Burgeoning Asian demand has made the old Opec price range wholly redundant. What's more, Western economies have proved much more resilient to high oil prices than in the past.

The upshot of all this is that even with high oil prices, peak oil may be reached much sooner than anticipated, with potentially far-reaching consequences. Just remember, modern prosperity, from hyper-efficient transport and agriculture to our great cities and, through improved sanitation, greatly enhanced health and longevity, are built more on oil than anything else. Nor, as things stand, is there anything that might replace it.

Tesco still leads, so why the discount?

Phew! Despite its size, Tesco hasn't yet been toppled from its perch as Britain's fastest growing supermarkets group. Like-for-like sales growth in the Christmas trading period came in at 5.7 per cent, excluding petrol, still marginally better than the 5.5 per cent of a resurgent J Sainsbury. Perish the thought, but boy, must they have squeezed at Tesco's Cheshunt headquarters to get those extra couple of basis points.

Whichever way you cut it, this was nonetheless a cracking performance, so how come the shares fell nearly 2 per cent? The stock market has grown accustomed to excellent results from Tesco, and for a change, the latest trading update was actually no better than expected. Indeed, international sales growth was even a touch disappointing. Yet the reaction is also indicative of a wider problem in investor perceptions.

Over the past year or two, it has become fashionable to think that Tesco may be approaching the high water mark of its UK growth and influence. I should know, because I've argued it frequently enough. For years, Tesco enjoyed an unencumbered landscape on which to roam. Now the company faces a double constraint of tougher competition at a time of less benign regulation. Compensating with overseas expansion is all very well, but it's high risk and capital intensive. The upshot is that while the stock market as a whole has risen over the last year, Tesco has remained as flat as a pancake. Even Sainsbury's, which has been trouncing its profits to claw back custom, has outperformed on share price.

Time for another reappraisal. Whatever its drawbacks, Tesco is the best managed and positioned company of its type in Britain, and one of the best in the world. As a long-term investment, it must surely still be a better bet than Sainsbury's.

One longstanding criticism of Tesco in the City is that it is mean with its shareholders. This is the view that portrays Tesco as more of a customer co-operative than a money-making machine, preferring to reinvest its profits than give it back to investors. There's an element of that, certainly. It is also much more paternalistic than generally imagined. For instance, it remains one of the few FTSE 100 companies with an open-to-new-members pension scheme.

Yet the parameters it sets and achieves for return on sales and capital have always seemed to me to get the balance about right. The purpose of business is to serve the customer. Companies that hold this principle dear, as Tesco does, stand a much better chance of long-term success than those that put short-term shareholder value above all else.

j.warner@independent.co.uk

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