Personal Capital: The new new rules
By R. Scott Raynovich
Redherring.com, April 06, 2000
Wow, did the markets ever punish those that do not believe in discipline.
Last week, this column examined the potential for a serious correction
and what you might do about it. We had no idea it would come that
quickly.
At some point last fall, before the Nasdaq Composite Index started a
blistering run in which it doubled within a period of eight months,
somebody decided to throw the rules out the window. Moving averages?
Hah, who cares about those. Valuations in line with growth? Nah, forget
about it. Profit-taking? Let it ride, baby. We all became careless and
greedy. Eventually, the markets became impatient with such recklessness.
The market needs rules -- and if you don't supply them it starts making its
own.
The Nasdaq Composite is still up more than 90 percent since January
1998, so we have by no means returned to safety. But you might start
deploying some excess cash into leading companies that have had their
wings clipped a bit. Let's just face it: things got a little out of hand for a
while.
REALITY BITES
The brutal reality of the combined 10 percent decline on Monday and
Tuesday reminded us that there is a need to return to some rules -- the
new new rules. Let's keep things in control this time. Let's be reasonable
about this. Let's regroup and regain our sanity.
Here are the new new rules:
1.The weak are toast. Are you meek in soul, poorly capitalized, or
unreasonably leveraged? Can't handle volatility? If these attributes
apply to you as either an investor or a businessperson, forget
about it. Get a day job. Buy treasuries.
2.Every company is a startup. A great company is only great on the
day it announces a great quarter. The day after its earnings
announcement, it's a startup again.
3.A company that has never shown a profit should never be valued
over $20 billion.
4.Avoid companies in which the executives regularly brag about their
market capitalizations and implore the public to buy more of their
stock. Especially if these companies are breaking some of the other
rules.
5.The $5 billion/$100 million rule: companies with less than $100
million in projected annual revenues are not allowed to have a
market capitalization of more than $5 billion. This, of course,
requires more analysis of the growth rates, but enforcement of this
rule maintains a bare minimum sanity level for the general growth
paths of technology companies. It also provides a disciplinary
framework for taking profits.
6.Real technology markets matter. Examine the company. Invest in
companies that are real technology innovators with rich customers.
Is the company supplying complicated, proprietary networking gear
to deep-pocketed telecommunications vendors or is it
experimenting with avant-garde business models for selling beauty
products over the Web? If it's the latter, it's in trouble.
There is opportunity in the stocks that are now operating within the rules.
As we sift through the companies that we've been following in this column
and apply the new new rules to them, a few names emerge.
NETWORKING NEWS
First up, the networking hardware sector. Some of these stocks are down
50 to 100 percent in the last three months. With strict adherence to rule
No. 6, this is the first sector in which to jump back. Extreme Networks
(Nasdaq: EXTR), of all the networking players, appears to be living most
strictly within the rules. The company is now profitable and headed
toward a $200 million sales year. Its market capitalization is $3.8 billion,
which seems relatively sane and fits comfortably within rule No. 5, even
though its sales are double the $100 million needed for compliance.
In recently turning profitable, Redback Networks (Nasdaq: RBAK) now is
operating within the rules and its share price has been brought back to
earth. The company surprised everybody by turning profitable within
months after turning public. Sycamore Networks (Nasdaq: SCMR) was
breaking rule No. 3 before last month, but it is now just barely playing
within the rules after having $100 chopped off its share price. It also
recently turned out its first profitable quarter. Sycamore's position as an
early mover in the optical space may explain its premium in the market.
Cacheflow (Nasdaq: CFLO), a recent IPO, is in a monster of a market --
Internet performance hardware -- and the company recently cut an
interesting deal with Akamai (Nasdaq: AKAM). Cacheflow stock broke rule
No. 5 and was punished for it. The stock now is trading almost at half its
all-time high. Its market capitalization is a manageable $3.5 billion,
bringing it within the rules. Not a bad buying opportunity.
The valuations in certain networking companies still raise caution flags.
Juniper Networks (Nasdaq: JNPR), for example, is still breaking rule No. 3,
with a nerve-racking valuation of $35 billion. If you own a basket of the
networking stocks, you can afford to toss some Juniper in on a whim, but
if you are looking for one safe bet in the sector, forget about it. |
