Serious Money: Early investors may be tempted to cash in, but it could be wiser to stay the course, writes Chris Johns

Google has been an amazing story ever since it first hit our screens in September 1998. Anyone coming to the new search engine - apparently named as a play on the word googol, the number 1 followed by 100 zeros - from the then industry leader, AltaVista, was immediately hooked.

Sergey Brin and Lawrence Page had found a way to put some sense of order into the often thousands of results that simple searches threw up; they had found a way of sorting web pages in terms of relevance. Using technology developed while at Stanford University (some of which is still licensed from their alma mater), Brin and Page launched a company that is worth, at time of writing, close to $50 billion.

Wall Street battled with Google over the manner of its initial public offering (IPO) and its price. The company stuck to its guns and upset the investment bankers with an innovative offering but had to climb down over pricing. Of course, as it turns out, anyone who bought the stock at the August IPO has already doubled their money.

Google's eye-watering rise culminated last week with a 15 per cent jump on the day after it announced third-quarter results. Having made so much money, early investors must be tempted to cash in. Traders are looking to short the stock and articles about another internet "bubble" are starting to appear.

But some smart money did buy Google and appears willing to stay the course: Bill Miller, head of fund management at US financial services firm Legg Mason bought a whopping 12 per cent of the IPO. Mr Miller is no slouch at investing: he has beaten the S&P index for each of the last 13 years. Another holder of an even larger slug of Google is Boston-based Fidelity. Will either of these well-known firms be tempted to sell, despite their belief in the value of very long-term investments?

Google's third-quarter results were good, but not so out of line with market expectations that they warranted a 15 per cent share-price jump. Perhaps the markets thought that the analysts were hyping the company in a manner reminiscent of the late 1990s.

Certainly, the numbers were impressive: gross revenues and net profits were double those from the same period a year ago. If we add back some non-recurring items - like the legal settlement with Yahoo and some tax charges - we find that net profit was around six times the level of a year ago.

When a company is young, we often discover turbo-charged growth rates. And it is always easy to strip out negative items to arrive at inflated profits numbers - still a common practice. But it has to be acknowledged that Google's accounting policies are relatively conservative. The reasonably independent research arm of Standard & Poor's (S&P), recently suggested that the gap between core and operating earnings (one measure of profits exaggeration) is likely to be very small for Google's results.

Can we value Google? When a company is doubling revenues and profits in the space of a year the analytical problems are enormous: any valuation exercise will be even more sensitive than usual to the assumptions - guesses - we make about future growth. If the company doubles its earnings again over the course of the next year - very unlikely but who knows? - and growth slows only gradually thereafter, today's share price could well look cheap.

Google trades at around 150 times the last 12 month's earnings. Even without all of the problems associated with PE ratios, we might be tempted to conclude that the stock looks a tad expensive. But it all comes down to growth. For example, if we assume that gross margins fall by 10 per cent (a bit more competition and more costs) and quarter- on-quarter revenue growth drops to 10 per cent (compared to 15 per cent for the last quarter), Google's PE ratio comes out at "just" 45 times next 12 months earnings. But if we play with those margin and growth assumptions, we find that we can come up with a wide range of plausible outcomes.

Just prior to the IPO, S&P utilised a wide variety of valuation techniques to come up with a valuation range that suggested the company was worth between $33-$40 billion, implying the stock is now expensive (but not outrageously so).

Discounted cashflow exercises are as fraught with difficulty as the elementary PE calculations outlined above, so another popular method is simply to compare Google with its peer group.

Again, taking simple PE ratios, Google already trades a large premium to Yahoo's 93 times trailing earnings. Such relative calculations completely dodge the issue of whether or not Yahoo is expensive, which is another growth question: if consensus estimates of 40 per cent earnings growth next year with a slow fade thereafter are right, then Yahoo is probably still attractive.

If Yahoo and Google should be valued at the same level, and both grow as forecast by the optimists, then, believe it or not, Google might still be cheap. That's the power of growth.

Whether Google can maintain high growth rates will depend on competition and commoditisation. Search technology is improving all the time and the likes of Yahoo and Microsoft want more search revenues (which arise form advertising).

But Goggle's capacity to innovate might just be the advantage that sustains its growth. Its free photo-album software, Picassa, is a joy to use. And the recent roll-out of a beta (test) version of its search engine that scans a user's hard disk is nothing less than a work of genius. Anyone familiar with the growing problem of finding stuff on your PC will love this product: you can now locate virtually anything.

Microsoft can only look on with envy as one of the biggest weaknesses of its product range is poor searching facilities. Some people are wondering whether Google is planning to assault Microsoft in other ways. Anyone buying into this idea might want to consider a long Google - short Microsoft play.

Anyone buying Google shares at their current level is making a leap of faith about growth. That might be the right bet to make, but the Google share price is bound to take a stumble at some point: at least I hope it does. I will be looking for this as a belated opportunity to buy. I fancy the pessimists might have got Google wrong.