It was reported that Google Inc. (NASDAQ: GOOG) paid $1.65 billion for a company that had not yet earned any money. Google currently has a return-on-equity (TTM) of 23.11, a return-on-investment (TTM) of 23.26 and a profit margin of 29.02%. So if Google were to maintain these returns, or even a more conservative rate, say 20%, the investment needs to generate $330 million in a 12-month period. Anything less will dilute Google's earnings. I think, instead it may spend that much to integrate YouTube into the company, expand its technology and features, promote it, defend it from legal assault and maintain its overall leadership and market share. If Google can't do that, it paid too much.

Before I continue, please consider Steve's retort that Google went up in value in the two weeks following the news of the acquisition. This is totally irrelevant since a direct correlation is not evident and the stock later went back down. Stocks tend to go up on things that are deemed positive news and down on negative news. This is based on people's speculation about the future value of the company. I cannot support all this speculation.

Steve continues to give credit to Google for every move it makes. This is strange, because it is his sentiment, not an investment principal, and some moves Google makes are better than others. Even when it makes great decisions, they are not all equal. In addition it is a fallacy that "The more you utilize their services, the more you want to!" This is blatantly false in part and in whole. They keep raising the price of gasoline and we all keep coming back for more - - should the oil companies assume that raising gas prices is a stimulus for more business?

Regarding the $250 billion valuation, it is possible perhaps, but soon? Not very likely. Google closed up yesterday at $470.96 with a capitalization of $146 billion.

Back to why Google paid too much. If it cannot earn the $330 million in year one, YouTube will have to earn in excess of that in the following year or it will be even more dilutive to the company and shareholder value. By the end of the second year, Google will now have to have earned $330 million + $66 million (20% dilution factor) + $330 million = $726 million. This does not account for a lot of other costs and the fact that it is actually making more than 20%. It might be that it will have to earn $800 million to $1 billion to make it a worthwhile investment. Going forward, it is in a race to ramp up earnings, but Youtube also faces increased competition with each passing day which is also dilutive to its value.

Video on the web will become ubiquitous like every other website feature and Google simply bought themselves a head start just like AOL had in many areas, just like Yahoo had in many areas, and both watch their stocks set adrift for periods, as they are now. When all was said and done they found they had overpaid for just about everything.

The smart thing that Google did was to buy YouTube without any cash in the deal. The all-stock deal was smart because the brain trust at Google knows that they are playing with monopoly money ... even though Google had the cash to pay for YouTube outright. They decided it was better to hold cash which is not earning much (maybe 4 to 6%) rather than conserve stock (theoretically earning 20%+). So for me to say that Google overpaid is not unreasonable and is supported by the Google board itself. Most importantly, if it would not buy it with cash, why should anyone else?

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Sheldon Liber is the CEO of a small private investment company and the vice president for design and research at an architecture & planning firm. Check out his other posts for BloggingStocks here.