Friday February 26, 6:45 pm Eastern Time
Internet stock infatuation, just a passing fancy?
By Pierre Belec
NEW YORK (Reuters) - Internet stocks are still on Wall Street's most wanted list but
the experts say the gold rush will not pan out for most of the online gamblers.
The buying frenzy is now in its second year as investors gobble up any stocks that
have a ''.com'' connected to them, drawn by the shares' explosive gains.
But like anything that's new, the companies that are expanding the global computer network will have to prove
themselves.
The experts are betting that many of the stocks will go bust and the companies with their nerdy-hip appeal will wind up
on the ''What ever happened to ...'' list.
''The Internet is the biggest bubble the stock market has ever created,'' said James O'Shaughnessy, a money manager
and author of the investment strategy book ''What Works On Wall Street.''
''When we review the bubble after it has been popped,'' O'Shaughnessy says, ''we'll compare it to the most famous
scandals, frenzies and Ponzi schemes.''
Internet stocks have been on a virtual vertical climb because investors are indulging in fantasies about the companies'
potential earnings, he said.
''Online book seller Amazon.com, for instance, has a market capitalization that is bigger than all of the books that are
sold in this country,'' O'Shaughnessy said. ''What fascinates me is the myopia of investors, and they just don't get it that
this has happened many times before.''
Some Internet stocks with no earnings history are trading at an eye-popping 2,000 times anticipated 1999 earnings, and
they command outlandish capitalizations that exceed those of long-established blue-chip stocks.
Amazon.com, for one, has a market valuation of some $10 billion.
eBay Inc., the popular Internet auction site, is trading at about $280 after going public just five months ago at less than
$20. E*Trade has zoomed more than 900 percent since it went public and BroadVision Inc. has soared 500 percent.
Veteran Wall Streeters are scratching their heads, trying to understand how such risky stocks can be rewarded when
others with real bullish fundamentals are being snubbed.
The experts said that as many as 80 percent of the Internet companies cannot justify their high stock prices.
Have the rules of investing changed? No, they are simply being ignored by a new breed of investors who are not
drawing on the historical behavior of the stock market.
William Valentine, investment manager at Valentine Ventures LLC, says speculative mania have been around for years.
''They're characterized by the antithesis of the law of elasticity,'' he said. ''In economics, demand for a good falls as its
price rises, but in a mania, the higher the price of a stock goes, the more a stock is in demand.''
The last mania was in 1980s, when biotechnology companies were hot, hot, hot.
''Any IPO with the words 'molecular,' 'gene,' 'zyme,' or 'bio,' in the company's name was treated as benevolent,'' he
said. ''These days all a company has to do is call itself 'anything.com' and the market treats it like it prints money.''
Every one of the past mania has ended the same way. ''Prices eventually collapse as the hype fades and reality sets in,''
Valentine said.
Early in the century, some 500 companies made radios and radio stocks were the thing on Wall Street.
''Radio Corporation of America (RCA) was the America Online or Yahoo! of that era,'' said Brad Perry at David L.
Babson Inc., an investment advising firm. ''In just a few years, its stock price rose from $10 to $505 before collapsing
and staying underwater for decades.''
Today, not a single publicly traded U.S. company makes radios. Only General Electric Co. and Motorola Inc. -- two of
the original radio producers -- are still in business.
In the 1920s, 400 American companies built cars; now there are only two (following the merger of Chrysler Corp. and
Daimler Benz AG).
Perry said that the big problem is that investors have become too excited about the Internet and they are overpaying for
the stocks.
''Eventually, when the early entrants in these new markets establish an earnings record -- good as it may be -- it will not
be good enough to justify the stock prices that the mania has produced,'' he said.
In the end, there will be some winners among the Internet companies, but most of the newcomers will vanish.
''The mortality rate will be huge for Internet companies and 80 percent of the firms that are in business today will be out
of business five years from now,'' O'Shaughnessy said.
The survivors will be the companies that can bankroll the biggest advertising budgets and the best businesses.
''Picture for a minute what will happen to Amazon.com when, let say, 'BestPrice.com' -- a (theoretical) consortium that
is backed by big money -- comes on line and guarantees the best price or triple your money back,'' he said.
''It can happen in the bookseller business, which has no barriers to new entries,'' he said. ''People will not have any
loyalty to Amazon.com and Amazon's business models will disappear overnight.''
O'Shaughnessy added that only a handful of companies will succeed. ''Ultimately, the companies will be consolidated
because that will be the only way to stay in business.''
He said the Internet stocks, particularly the retailing sector, are vastly overpriced.
''Even if online retailing grows at the most optimistic projection, it would still control only 5 percent of the U.S. retail
dollars five years from now,'' he said.
Investors are still rushing to be the first buyers of online stocks that come on the market, even though the risk-reward
meter long flipped over to the unfavorable side.
''It's like fighting for a deck chair on the Titanic,'' O'Shaughnessy said. ''People will need to go back to basics, such as
what they're paying for every dollar of cash flow, and weigh the revenues since most companies don't have any
earnings.''
What would be the early warning signal that the bubble is about to burst?
''The catalyst will be a failed IPO,'' he said. ''When a company comes out with an initial stock offering that goes
nowhere, this will tell us the mania and thought contagion is wearing off.''
It could lead to a bloodbath for investors who loaded up on the sector.
''When people realize that the 'Greater Fool' isn't there anymore, they'll rush for the exit and the same things that drove
up the Internet stocks will work in reverse,'' he said.
Propelling the stocks on their first day of trading has been the small number of shares, or floats, that have been put into
the public's hands.
But this shortage of stocks can work both ways. It can also create a dangerous situation and tremendous price
fluctuations when people turn bearish and want to cash out.
''The Internet mania is nearing the end of the average time period for mania and the dam could burst before or during
the summer or at the very most, in one year,'' O'Shaughnessy, who sees some benefits from a washout of Internet
stocks, said.
''A collapse of Internet stocks will be good for the overall market. It will get people back into thinking in terms of reality
and get back to the traditional way of pricing stocks,'' he said.
(Questions or comments can be addressed to Pierre.Belec(at)Reuters.Com)
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