Roundtrip.com
How to avoid it.
By Robert Kleinschmidt
The consensus is slowly building that the Internet bubble has burst.ÿ
Astute market watchers have known this almost from the beginning of
the rout in the NASDAQ, but most analysts, day traders and market
commentators resisted the notion for a number of weeks.ÿ Even now,
the destruction of wealth brought on by the collapse in Internet
valuations has been barely noticed by the man on the street.ÿ Dot com
millionaires remain a fixation of the general public as well as the
business publications and media, even as the market is eroding their
fortunes.ÿ
It is not surprising that this sudden turn for the worse has been met
with fierce denial.ÿ In his charming, if simple bestseller, Who Moved
My Cheese?, Spencer Johnson notes, ?The more important your
cheese is to you the more you want to hold on to it.?ÿ The Internet
mania became very important to a huge number of people.ÿ It wasn?t
just the wealth created, although of course it was that too. Perhaps
more important was the enormous cultural impact the bubble
nurtured.ÿÿ It empowered thousands with the myth that ?investing?
was an easy business and risk was an outdated notion.ÿ It legitimized
the notion that investment professionals were somehow, prior to the
Internet revolution, playing an inside game to the disadvantage of the
general public, and that the Internet had blown open the doors to the
smoky backrooms where the big boys were making their deals.ÿ It
convinced thousands that they could be more productive staying home
watching their screens and CNBC than going to work.ÿ It imbued the
previously much maligned Generation Xer?s with status.ÿ It changed
the way much of the business world dressed.ÿ It bent the rules on
compensation.ÿ With all this going for it, no wonder the change has
been resisted.
The neat trick behind the Internet phenomenon was that a great deal of
?investing? in the Internet occurred on the Internet.ÿ This giant
feedback loop became a self-fulfilling prophecy for the legions of new
disciples.ÿ And, it wasn?t just the investing.ÿ As more and more Internet
companies were formed and floated, it became apparent that the
revenues of many of these companies, to the extent that they existed at
all, were generated from other Internet companies.ÿ But far more than
revenues, these companies were spending venture capital and IPO
dollars.ÿ The principle nexus between the old economy and the new
was in field of advertising.ÿ Billions were spent on attracting eyeballs.ÿ
The business model being attract the eyeballs with advertising, and
then charge advertisers for access to them.ÿ This was another feedback
loop.ÿ In practice, of course, it didn?t work.
Still, there are those who expect a turnaround, not necessarily to the
previous highs, but well above current valuations.ÿ It is to these folks
that this note is principally addressed.ÿ A large number have vowed to
wait for their previous high flyers to regain some of their former luster
before selling.ÿ You know who you are.ÿ This is a dangerous fantasy.ÿ
It is not just that most of these stocks will never see their former
highs.ÿ It is more likely that a high proportion of them will go to zero.ÿ
Even the best companies in this ?space,? to use the term most favored
by the new crowd, will decline by 75 to 80 per cent.
ÿHere is some simple math.ÿ When a stock goes up by four hundred
per cent, and many internet equities did, it has to decline by 80% to get
back to the starting point, its original IPO price, for example.ÿ If a
shareholder bought at the initial public offering price and rode the
stock all the way up and all the way back down, he might be able to
say, ?Well, at least I haven?t lost anything.ÿ It was only paper
profits.?ÿ I have heard comments like that.ÿ Alas, that is not the way it
usually works.ÿ Stocks are bought on the way up.ÿ Indeed, in the most
recent market stocks were bought precisely because they were going
up.ÿ And much of this buying was done on margin. (During the height
of the mania one of my clients, who also manages some of his own
funds, explained to me that it was crazy not to use margin.) When
markets turn initially, holders of some of the most spectacularly
performing stocks yield to the temptation to buy the dips, so confident
are they in the stocks which have treated them so well in the past.
(Another of my clients took the ?opportunity? to double up on his
position in Safeguard Scientifics, an internet incubator selling at a
300% plus premium over the internet inflated values of its underlying
holdings, at 50.ÿ As I write this, Safeguard is selling at 34.)ÿ There is an
asymmetry to markets.ÿ More money is lost on the way down than is
made on the way up.
What to do?ÿ Our advice is to take your lumps.ÿ The market is full of
solid investment opportunities, and more are being created everyday.ÿ
This is a good time to upgrade your portfolio with solid value names
and well run mutual funds.ÿ The money you made, or thought you
made, on the fantasy ride is gone.ÿ High technology and Internet
names still have a long way down to go, and they won?t be the sector
that leads the market back up when it does turn.ÿ A roundtrip can be an
expensive ride.ÿ
Robert Kleinschmidt
May 22, 2000
¸ Tocqueville Asset Management L.P. |
