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Tuesday February 18, 12:05 PM
Dot-Comeback: Internet Stocks Sizzle Again
By Jeff D. Opdyke
THE VERY SECTOR that helped kill the bull market is hot again.
In large part, investors are betting that the market overreacted during the past three years. The basic argument: that the Internet is here to stay, and the surviving companies probably have weathered the storm. More than 41% of the remaining 209 publicly traded Internet companies were profitable in the fourth quarter, compared with 17% a year earlier, according to Pegasus Research International. Many of the questionable concepts like Pets.com, which sold pet supplies, and WebVan, an online grocer, are long gone.
Some investors are wading into brand-name companies such as Amazon and eBay that are now profitable and rapidly attracting new customers. But others are snapping up the kinds of small Internet companies that had become practically a joke in the past few years. The difference now is that some of these companies have a lot of cash on their books, are modestly profitable or near break-even and have real products. As a result, they seem less at risk of disappearing. Their share prices are also battered enough that some investors see a lot of potential upside.
In recent months, some well-known money managers have become buyers of these stocks. Peter Lynch, the former Fidelity portfolio manager, has been snapping up Internet stocks -- he won't say which ones -- recently for his personal portfolio. The Pimco PEA Innovation Fund bought both eBay and WebMD late last year. The Smith Barney Peachtree Growth Fund was a recent buyer of Amazon.com. And the Frank Russell Tax-Managed Mid & Small Cap Fund has grabbed shares in Internet provider EarthLink.
The buying comes at a time when investors are searching desperately for winning investments anywhere. The bond market has been about the only bright spot for U.S. investors, but few believe that bonds are poised for another big gain this year. And investors keeping their stash in cash are getting some of the lowest rates in decades.
The stock market remains far more bleak. Despite the 159-point gain Friday -- the market was closed yesterday -- the Dow Jones Industrial Average has lost roughly 5% so far this year. The market could be heading for its fourth down year in a row, which would mark its worst performance since the early 1930s. Of the 94 sectors measured in the Dow Jones U.S. Total Market Industry Groups, Internet stocks make up one of only a handful that are up for the year.
Buying online companies still isn't for the fainthearted. And in a reminder of the agony that millions of investors went through three years ago, it isn't clear how much more upside is in these stocks. (Yes, you may have missed it again.)
Indeed, the sector remains far more volatile than the market as a whole. That means if the tech economy slumps further, these stocks are likely to be slammed hard. In addition, valuations on some of the best-known remain pricey -- though nowhere near the nosebleed levels of early 2000. Amazon, eBay and Yahoo trade between 57 and 63 times their expected 2003 earnings. By comparison, the average stock in the Dow Jones Industrial Average sells at 17 times expected 2003 earnings.
Plenty of skeptics remain. Mike Weiner, managing director for Banc One Investment Advisors, for one, believes Internet stocks are still overvalued as a group. He owns only eBay.
Even the people who are fans of Internet stocks agree they're far from safe. "It is still the highest-risk category of stocks, but Internet stocks still offer some of the best return opportunities," says Ryan Jacob, who runs the Jacob Internet Fund, which was up 60% in the fourth quarter, and is down about 1% on the year.
Some of the best-known companies from the 1990s, such as Amazon.com, are in the black now. They have survived the rotten economy of the past couple of years, they have a growing roster of customers and an expanding list of products. Even while traditional retailers had a spotty Christmas, online retailers did relatively well. For example, Amazon.com's fourth-quarter sales rose 28% from the year-earlier period.
Another company attracting interest from investors: WebMD, which runs a popular Internet portal for consumers and provides practice-management services for physicians. It was losing roughly $100 million a quarter during the Web's boom days. Now, the company is modestly profitable, earning about $4.5 million, or a penny a share, in the third quarter.
What makes the small companies enticing to some Internet investors is that their stock prices reflect basically just the value of the cash they have in the bank. Mr. Jacob, the Internet fund manager, focuses in particularly on companies that are modestly profitable or operating at near-breakeven levels. As a result, they're not burning through their cash as they once where.
Companies that Mr. Jacob has recently grabbed: Agile Software, which makes product-lifecycle-management tools, and InfoSpace, which provides wireless and Internet software services. These are "orphaned companies that the market has just forgotten about," says Mr. Jacob, "and which are well-positioned for a gradual recovery."
InfoSpace, which operates search engines among other businesses, is starting to benefit as advertisers pay search engines for getting Web surfers to click on to particular sites.
Bill Whitlow, manager of Safeco Northwest Fund, likes Seattle's RealNetworks, which he relies on to listen to Seattle Mariners baseball games when he is traveling. RealNetworks, down about 3% this year, helps facilitate a lot of the sports and music content on the Web. "They have a model that makes sense," Mr. Whitlow says.
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