Another way of looking at the Net
Patrick Bloomfield
National Post
I wish I had $10 for every new investment theory I have come across in 40 years of business writing.
I would be a rich man.
They all have to meet one test. When applied to any one particular stock or stock segment or marketplace, will investors be standing in the aisles and throwing money at the stage, or heading for the nearest exit?
The choice has precious little to do with market reality, otherwise, we would all be buying at the bottoms and selling at the tops. The availability of money to throw at the stage depends largely on the state of the economic cycle, and the willingness to throw it depends on investor sentiment, a fickle thing.
With this caveat in mind I read a paper on the valuation of Internet stocks kindly sent me by Professor George Athanassakos, of Wilfrid Laurier University's School of Business and Economics. I have great respect for him. To my mind, he came up with the only convincing explanation for the propensity of markets to do best at the turn of the year.
He proffers two rational reasons for not viewing Internet-related stocks according to traditional growth valuation models. He argues that, just because a venture is risky in its initial stages, one should not assume it will be equally risky for all time. One should break down free cash flow forecasts into stages and evaluate (and apply an appropriate discount to) each stage on its own. Another justification he advances is the now-familiar "real option" theory. As Athanassakos puts it: "The first stage of Web site development and investment is equivalent to buying an out-of-the-money option, real cheap. This value has to be explicitly considered when valuing this pure play high-tech company."
In fact, VPs of finance in high-tech companies use the Black- Scholes option model to value their own and other companies' stocks, feeding in their own assumptions. As Athanassakos observes, high price-to-earnings ratios may indeed be justified based on the option to great riches in the future. Investors are prepared to pay for a small probability of a "high payoff."
That brings me back to where I started. We live in very unusual times. North American investors have more money to invest, and a greater yen to invest it, than at any time since I came to Canada 27 years ago. And they have the advantage of bright young people prepared to take that money and use technology and the Internet to translate it into great riches. My concern remains that happy coincidences of ready money and a technological revolution do not last forever. They get moderated and/or knocked to the ground, maybe by no more than the realization that they have been taken too far.
I am not going to use the over-worked analogy of tulips. But I do feel Internet speculation is beginning to moderate into a more accurate picture of what the real revolution is all about. Andrew Roblin, CEO of University Avenue Funds, sent me a copy of the global markets roundup edited out of Minneapolis by Larry Jeddeloh, who has achieved remarkably strong numbers for this fund group's international fund. Jeddeloh notes that only one out of three e-commerce Nasdaq stocks is up this year. (Note, too, the relative subsidence of the Linux mania.) By contrast, Jeddeloh sees e-business as one of the Nasdaq sectors with the greatest current appeal, and that makes sense. Productivity, rather than selling things per se, is the real gain.
If I have been right in arguing that market multiples are slowly being adjusted to give the greatest weight to any business sector where productivity improvement, and therefore profits, will be the greatest, then I have my critics.
As one well-known technology analyst asked in an e-mail, if the market is indeed sorting out the "good" from the "bad," then what about all the frantic speculation on the Canadian Venture Exchange? Something other than the cream has been rising to that particular top.
The best answer I can give is to recall the junior oil boom of the 1980s. The froth remained on the boil even after it became obvious that world crude oil prices had peaked. (Today, by contrast, oil prices are up there and investors do not want to know about it.) |
