Are you referring to the "Heard on the Street" column? It was out yesterday.
Does Rude Awakening Loom
For Dreamy Concept Stocks?
By ROBERT MCGOUGH
Staff Reporter of THE WALL STREET JOURNAL
Oh brave new world that hath such concept stocks in it!
Sure, Shakespeare's heroine Miranda said "people," not "concept stocks,"
in "The Tempest." But she was only living on a magical island -- not trading
in a magical stock market.
And what an enchanted time it has been for concept stocks -- those
levitating on little more than a wing and a business plan. However, in
previous speculative booms like this, investors have ultimately gotten wind
that something was rotten in the state of concept-stock valuations.
VerticalNet, which runs business-to-business commerce sites on the
Internet, has a paranormal stock-market value equal to 326 times its
annual sales as of Tuesday's price. (The median for the broader market:
two times sales.)
Chasing Clouds?
Concept investors buy a company's shares because they like its business
concept, and future prospects, even though the price is high, and past earnings
don't justify great expectations. Some "concept stocks":
Market
value
(in billions)
Share
price
Price-to-
sales
ratio
Volatility
VerticalNet
$7.01
$197.00
312
10.1
Leap Wireless Intl.
1.67
88.25
174
10.3
Be
0.69
20.06
76
15.6
Geoworks
0.62
35.00
71
16.9
ZixIt
0.54
35.03
-- *
10.8
General Magic
0.40
9.63
1761
15.2
Sunrise Technologies Intl.
0.39
8.44
2,781
10.8
Quepasa.com
0.14
10.00
212
11.4
*No sales
Notes: All figures as of Feb. 15. Price-to-sales ratio: share price divided by sales,
and then divided by number of shares outstanding; volatility: difference between
daily high and low divided by the share price; daily average
Sources: Bogle Investment Management, CompuStat
And on just any old average day, the stock of General Magic -- which
now makes voice-enabled software for use on the Internet, in cars and
elsewhere, after an earlier concept failed -- swings in a range that adds up
to more than 15% of its closing price (compared with less than 5% for
stocks in general).
The magic behind these highflying stock prices? Investors believe their
business concepts, and future prospects, are thrilling. No past earnings
could justify such great expectations.
Concept stocks have been highfliers before, particularly in 1969 and 1972.
In those instances, speculation on such ethereal concepts preceded
significant market downturns. Of course, nobody rings a bell and says the
stock-market party is over, and such stocks can continue soaring in the
meantime.
So while concept stocks are extremely risky, in this market it just doesn't
pay to fight against them, says John C. Bogle Jr., president of Bogle
Investment Management. "The more overpriced a stock is, the more
overpriced it can become," he says. "There is no sensible metric for
valuing" such stocks.
That's why Mr. Bogle, like some other adapt-or-die investors, is making
sure he has at least a little exposure to them. He doesn't want too much
exposure, just enough that he isn't left out of the revelry -- maybe half to
two-thirds the weighting that they would have in an index of stocks he is
trying to beat. He does this even though he concedes: "It's contrary to most
of the stuff I was taught about investing."
Concept stocks are alluring: Who can resist the quest for the next
Microsoft (which, back in the '80s, was itself a concept play)? Maybe it
will be Be, a company on Mr. Bogle's list of stocks that fall under the
definition of concept plays (though not one he owns). Be has created a
state-of-the-art operating system for computers that, proponents say, is
light-years beyond Windows. Then again, they also said that about the
Macintosh operating system.
Still, the Be operating system might catch on in the emerging market for
Internet appliances, which are dedicated to connecting with the Web.
Shares of Be are trading among eager investors so quickly that, in a year,
more than six times the company's shares outstanding changed hands. For
stocks on average, only about half the shares outstanding trade during a
year.
Which leaves this longer-term question for investors: Is it to Be or not to
Be?
Despite the allure, concept stocks lost money for years, working about as
well as Dad's magic tricks at a birthday party. Since 1980, if you only
bought concept stocks as defined by Mr. Bogle, you would have lost
money, cumulatively, for nearly 20 years.
But since late 1998, it is as if Dad reached into a hat and actually pulled
out a real rabbit. Concept stocks have risen sharply, wiping out the losses
of the prior 18 1/2 years, and even started making money on a cumulative
basis. The return on concept stocks in the 15 months through the end of
1999 was 247%. In the same period, the Standard & Poor's 500 Index
gained 40.1%.
Concepts are "castles in the air" by definition, so how does Mr. Bogle
quantify concept stocks? He looks for three characteristics. First, the
stocks have extremely high price-to-sales ratios. Price to earnings ratios
won't work because these companies so often are losing money.
Like height in the National Basketball Association, the definition of a tall
price-to-sales ratio has expanded over the years. In the 1980s, concept
stocks tended to sell for about three or four times revenues. In the early
and middle 1990s, as interest rates dropped and earnings accelerated,
such stocks sold for around 10 times revenues. Today, concept stocks sell
for a price-to-sales average of 50 times -- on average. The median of
more than 2,800 stocks tracked by Bogle Investment management is two
times sales.
Second, Mr. Bogle looks for frenetic investor activity. Currently, shares of
the concept stocks tagged by Mr. Bogle trade hands twice in a year for
every share outstanding. In comparison, the median stock has about half of
its shares outstanding trade during the course of a year, up from 12% in the
early 1980s.
Third, concept stocks are volatile on most days. The universe of stocks
Mr. Bogle looks at includes nearly all U.S. stocks "liquid" enough to trade
$60 million to $70 million in stock a year. Concept stocks had price
swings of nearly 10% on an average day.
Mr. Bogle adds up these three rankings for the stocks he follows, and he
arbitrarily designates the 10% of stocks with the highest scores to be
concept stocks.
It is a fun group, and most of them are indeed growing very rapidly --
though whether that growth justifies their lofty stock prices is a question
that stodgy investors will continue to raise.
Consider Geoworks, which makes servers for distributing wireless data to
disparate devices, and also sells ads distributed to consumers.
Think about it: E-commerce and wireless combined, what a concept! The
stock, which closed at $32.9375 in Nasdaq Stock Market 4 p.m. trading,
sells for about 67 times annual sales of 50 cents a share, and shares are
trading at an annual rate of more than five times its shares outstanding.
A spokesman for Geoworks, which used to make operating systems for
"smart phones," says there is "no question this is a strong growth market."
He says that the stock's volatility suggests that there are a lot of day traders
plunging in and out.
And then there is ZixIt, which makes digital encryption technology that may
be used in e-mail and other applications. ZixIt is, in a sense, a perfect
concept stock, because the company has no sales at all, pending its
product introductions. (It sold a prior business tagging vehicles to raise
funds for the new business.)
The concept stocks that Bogle Investment owns tend to rank a bit lower as
concept stocks -- and sometimes even are profitable. The firm owns
Amkor Technology, which sells semiconductor packaging and test
services. At $47.1875 in Nasdaq 4 p.m. trading Wednesday, it sells for
about 39 times expected First Call/Thomson Financial consensus earnings
of $1.22 per share in 2000. Another concept stock Bogle owns is Allaire,
which sells software for Web development. At a price of $122.375 in
Nasdaq 4 p.m. trading Wednesday, it sports a price-earnings ratio of 382
times First Call consensus earnings of 32 cents a share in 2000.
"We don't want to have full market exposure; we think these companies in
many respects are outrageously overvalued," Mr. Bogle says of concept
stocks. Still, he is making sure he has some exposure to these stocks, since
they are hot now, and you never know when their run is going to end.
But make no mistake: It will end, and when it does, don't expect it to be
pretty. The Internet is "a concept with substance," says Chuck Hill,
director of Research at earnings tracker First Call/Thomson Financial. But
inevitably, concept stocks get overinflated, he says.
If today's concept stocks follow the patterns of their predecessors'
collapses in 1970 and 1974, Mr. Hill says: "You're going to see a lot of
companies sold out at a much lower price."
Write to Robert McGough at bob.mcgough@wsj.com |
