INKT a safer stock for conservatives read...
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Internet stocks for cowards
You can invest in a group of Net companies without abandoning fundamental analysis -- and still control your risk. Here's why Inktomi, AOL, RealNetworks and Schwab fit the bill.
By Jim Jubak
I'm not particularly fond of stocks that trade at 80 times earnings, let alone those that trade at 80 times projected revenue. And I certainly don't find it entertaining to own a stock that makes a regular practice of falling $17 in a day.
So why do I own shares of Inktomi (INKT)? Because all things considered, the stock belongs to a very small group of Internet equities that are suitable for cowards. ("Conservative investors," if you prefer.) Along with America Online (AOL) and some others, Inktomi is a stock for investors who believe, as I do, that the Internet is a revolutionary technology that must be represented in my portfolio but who aren't comfortable blindly putting money into a stock simply because everyone else is.
Conservatively inclined investors are usually advised to steer clear of Internet stocks. "Wait for the bubble to break," is a pretty typical comment. Or, "if you really must play this sector, invest in the big established infrastructure stocks," a particularly daring commentator might say. Put your money in Cisco Systems (CSCO), Lucent Technologies (LU), EMC Corp. (EMC), MCI WorldCom (WCOM) and Qwest Communications (QWST) -- they'll make money no matter what specific Internet companies turn out to be winners.
I certainly don't mean to disparage that advice; I've given it myself (see, for example, my Feb. 5 column "Plotting my road map for the post-PC race") and built a good part of my Jubak's Picks portfolio around it.
But I think it's also possible to invest in pure-play Internet stocks without completely abandoning fundamental analysis and without taking on unquantifiable risk -- as long as you limit your investing to a group of issues that I'm calling "Internet stocks for cowards."
The possibility of controlling risk
I don't pretend that it's easy to value these stocks using any form of fundamental analysis I know of. Or that you can definitively say that any of these stocks will be the Dell Computer (DELL) of the Internet, a stock that will return an average of 80% a year for the next 10 years. But I do think that each of these stocks offers the fundamental investor reasonable ways to tell if, in the future, the company behind the paper is likely to grow into the valuation currently awarded by the market. And each gives the fundamental investor a good chance to see a wrong turn at the company in time to sell before taking a horrible loss. In short, with my Internet stocks for cowards, an investor actually has the possibility of controlling risk.
So what earns a stock membership in this group?
Let me use Inktomi as an example. After that, I'll give you a list of a few other Internet stocks for cowards. Mind you, this isn't a list of stocks that I'd buy at current prices. I'd call it instead the group of Internet stocks that I'd consider buying when the price is right because I think they give me some chance of figuring out when the company is going well and when it's headed for potentially terminal hard times.
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Because of these four factors, investing in Inktomi isn't just a stab in the dark for me.
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Here are the four factors that earn Inktomi a place in my cowardly Internet hall of fame.
The company is built around a tested business model, one that has produced real profits for some other company in the long term. Inktomi charges a per-hit fee to companies such as Yahoo! (YHOO) that use its search engine software. That's a model that has worked for credit-card companies. Customers for Inktomi's new network caching software, the traffic server, pay Inktomi a license fee plus on-going maintenance fees. That's a model that has worked for established software companies. Inktomi will use the credit-card model for its newest product, the electronic-commerce shopping engine. The company has signed up 20 Internet portals and 350 merchants who will pay an average of 7% of revenue to Inktomi. Investors can be confident that it's possible to build successful companies around either of these business models.
The company is setting clear performance goals. Last quarter, Inktomi explicitly told investors what it hoped to accomplish this quarter. For one, it said it wanted to increase the number of queries served by its search engine. Queries served went up 22%. Inktomi said it wanted to add three new customers for the search engine; it added eight. The company wanted to sign up five new customers for the traffic server; 10 came on board. Finally, Inktomi wanted to launch a group to sell value-added services to traffic server customers. Did that, too. For the current quarter, the company has set five new goals: increase the number of search queries again, add new traffic server customers, take the shopping engine into full production, add new services for the traffic server service group to sell and add a fourth major product application to the Inktomi lineup.
Inktomi provides investors with consistently reported, easily located numbers that will reveal the development of any problems sooner rather than later. For example, a key issue for the company is its ability to sustain the dual model. The credit-card company model is much more lucrative than the software model, but it's also very expensive to customers. At some point, Inktomi will almost certainly face enough competition that customers will attempt to negotiate lower per-hit or per-sale fees or simply move their business to competitors that are willing to charge less. I'd watch that "search queries served" number to keep an eye on this problem. The 22% growth in search queries served last quarter over the previous quarter seems low in light of the continued tremendous growth of the Internet and certainly reflects the loss of a big customer or two to Alta Vista and other search engines.
The company's growth strategy is capable of justifying the current valuation at some point in the future, and the company seems reasonably capable of executing that strategy. Inktomi measures up particularly well on this criterion. Its core technology -- the ability to write "scalable" software that can keep up with the tremendous growth in Internet traffic -- is critical to the success of any Web application. Inktomi's product lineup, and therefore its future growth, is limited only by its ability to think of new or existing applications that would benefit from this power. That gives the company the ability to follow the growth of the Internet wherever it leads.
Inktomi isn't perfect on this scale. For example, I'm worried about its ability to sustain its higher per-hit revenue model. But then, I don't think any company is likely to dot every "i" and cross every "t." And because of these four factors, investing in Inktomi isn't just a stab in the dark for me. I understand how the company will make its money, how and where it will grow and what the potential problems are. And I can get the numbers that help me follow the progress of the company and identify problems before they kill the stock. |
