SOURCE: Riley Capital Research
The Riley Report: Tulipmania.com
HOUSTON, July 20 /PRNewswire/ -- Every serious investor and student of the rich history of market psychology knows the
cautionary tale of the grand dementia that swept Holland in the 1630's: Tulipmania. It is widely regarded as the mother of all
bubbles, surpassing the absurdity and egregiousness of all of the other speculative manias that would follow it; such as the
Mississippi Scheme and the South Sea Bubble in the early 1700's, the Roaring Twenties American stock market, and gold and
the Japanese stock market in the 1970's and 1980's.
Tulipmania likely earned its status as the ultimate financial mania due to the fact that the object of its desire was a commodity
that had never before (or since) been considered a store of value (unlike gold and silver) and had no real utility (unlike land and
oil). It did, however, offer the promise of a recurring revenue stream (like business ownership via common stock) from the sale
of cultivated bulbs -- hopefully at ever higher prices. The height of the bubble wrought by Tulipmania was breathtaking, with
the price of tulips rising by 5900% from late 1634 to early 1637.
The demand for tulips was so great that by 1636 they were regularly traded on the Stock Exchange of Amsterdam and on
many locals marts in towns throughout Holland, and for a while they even traded at the Exchange of London and in Paris.
''Tulip-notaries'' were appointed to help manage the booming trade. ''Tulip-jobbers'' traded the bulbs for short-term gains.
Futures contracts were created to ensure future delivery of bulbs at agreed-upon prices.
The mania soon trickled down from Holland's upper class, with ordinary citizens selling their property and land to reinvest the
proceeds in tulip bulbs. Fortunes were made overnight. The boom created a wealth effect that ignited inflation in other assets in
Holland. The price of houses, land, horses, carriages, and luxuries of every sort rose dramatically.
Interestingly, the passion for tulips was mostly confined to Holland. In Charles Mackay's classic book, ''Memoirs of
Extraordinary Popular Delusions and the Madness of Crowds'', the chapter on Tulipmania recounts the rather humorous story
of a foreign sailor visiting Holland. The visiting sailor, uneducated in the value of tulips, steals a bulb from a nobleman's table,
thinking it is an onion. By the time the nobleman catches up with the sailor at the docks, he has consumed the bulb with his
lunch of red herring. The value of the bulb that the hapless sailor ate? 3000 florin -- an amount that would have paid for 25 fat
oxen at the time. The poor sailor spent several months in prison for his felony.
Alas, it all ended rather poorly once the greatest fool had paid the top tick. A nagging fear that ''investing'' in tulips had instead
become speculation began to spread. As this fear supplanted greed there were soon many offers and no bids. Tulip prices fell
93% in the 10 months after the market peaked. Fortunes were lost, lives ruined, and Holland's economy was devastated.
There was no ''dead cat bounce''. One hundred years later tulips sold for less than 1/2 of one percent of their peak prices.
The purpose of this history lesson? Today many market pundits have likened investors' appetites for anything Internet to those
of Hollanders' for tulip bulbs. Might they have a point?
If one were to answer that question from the viewpoint of a strict Graham and Dodd ''value'' disciple, the answer is an
unequivocal and emphatic ''yes!''. As Graham and Dodd wrote in their book ''Security Analysis'':
''Unseasoned companies in new fields of activity ... provide no sound basis for the determination of intrinsic value. The risks
inherent in the business, an untested management, and uncertain access to additional capital combine to make an analytical
determination of value unlikely if not impossible. Analysts serve their discipline best by identifying such companies as highly
speculative and by not attempting to value them, even though we recognize that there will be pressure to make valuations of
initial public offerings (IPOs) and other unseasoned issues. The buyer of such securities is not making an investment, but a bet
on a new technology, a new market, a new service, or an innovation in established product markets. Winning bets on such
situations can produce very rich rewards, but they are in an odds setting rather than a valuation process.''
Try telling that to anyone who was allocated shares of Broadcast.com (Nasdaq: BCST - news) at $18 on Thursday night.
Better yet, try telling that to anyone who paid the top tick of $74 on Friday morning. It's a safe bet that they have never
cracked open Graham and Dodd's text, much less the Broadcast.com prospectus.
So what are we left with if we cannot value Internet companies with traditional fundamental analysis? Is this very question
indicative of Tulipmania.com?
Again, a strict value investor or analyst would answer ''nothing'' and ''yes'' to those questions. But such an investor or analyst
would also likely not have owned or recommended any of the top-performing stocks in the S&P 500, much less any Internet
stocks, since 1994 -- and as such would have missed all of the amazing upleg that began in January of 1995. So unless one is
content to remain in cash while awaiting the end of the current ''mania'' in this ''overvalued'' market, one must accept reality
and join the fray.
Wall Street's sell-side analysts have stretched mightily to meet the challenge of valuing Internet companies. Since most of the
companies have no current earnings, or prospects for earnings for years to come, analysts have made enormous leaps of faith
regarding their ability to see the distant future. Analysts have been forced to muster a power of clairvoyance Nostradamus
would have envied and peer ahead into the next century to estimate earnings that are then discounted back into today's dollars.
They have also been forced to focus on the metrics that are currently measurable; such as revenue, membership, and page
views, in the hope that gains in those categories will one day translate into profits. Obviously, neither method would be
acceptable to Graham and Dodd.
I personally believe, and have previously written publicly in a satirical manner, that the passion for some Internet stocks does
indeed smack of Tulipmania in that investors seem eager to pay almost any price for first-to- market and marquee brand
names -- with the Broadcast.com IPO being the latest example. Shares of Yahoo (Nasdaq: YHOO - news) and Amazon.com
(Nasdaq: AMZN - news) have also been bid up to price levels that clearly discount an enormous amount of future growth.
Still, I do believe that investors are earnestly trying to value these companies' competitive positions and future earnings streams,
and not merely hoping a greater Fool will take them out at an even higher price. Thus, I have only used the term ''Tulipmania''
in a sarcastic vein -- contrary to the charges recently made by an aspiring muckraker who cynically twisted my comments out
of context.
As long as the demand for ''blue-chip'' Internet stocks remains strong and the supply limited, they should hold or ''blossom''
from their current valuation levels. I continue to believe that this will inspire confidence in investors to reach for better value in
some of the second-tier companies that have more room for multiple expansion, and that relative valuation arguments are thus
sound and salient. Egghead.com (Nasdaq: EGGS - news), for instance, still trades at little more than 4X its forward run-rate
Internet revenues, vs. almost 17X for Amazon.com. Zapata's (NYSE: ZAP - news) emerging Internet portal business is valued
at less than 1.3% of the market cap of YHOO, while having registered many more than the mere 230,400 users such a market
cap implies on a comparable per user basis. I continue to believe that such yawning valuation gaps are likely to narrow as the
fundamentals continue to unfold in the months ahead.
The Riley Report is written by Louis Riley, principal of Riley Capital Research. It is distributed on an occasional basis to
provide timely commentary and opinion on individual stocks or industries that are making news. Opinions expressed are
subject to change without notice.
Riley Capital Research is a research boutique that specializes in highlighting investment opportunities that have frequently been
overlooked by most investors and that are not followed by the majority of Wall Street sell- side research organizations.
This report should not be construed as a solicitation or offer of any kind. Neither Riley Capital Research nor any of its affiliates
have received any compensation of any kind from any of the companies mentioned in this report.
Mr. Riley and affiliates of Riley Capital Research currently hold long positions in the common stock and/or derivatives of
Egghead.com and Zapata Corp., and Riley Capital Research recently issued a ''Strong Buy'' recommendation on both of
those companies' shares. Mr. Riley and affiliates of Riley Capital Research may from time to time hold long or short positions
in the other securities mentioned in this report.
Mr. Riley may be contacted by email at louisriley@aol.com. |
