Net-Stock Mania: Day Traders Have Some Big Accomplices
May 26, 1999
Institutions now have as much impact on valuations, especially long-term, as the rapid-fire gang
We all know the stereotype of day traders: They're the ones who work alone in their parents' den or in a pack in a hectic boiler room. Juiced up on caffeine, cigarettes, and the natural high of stock trading, they spend eight hours a day entranced by charts on computer screens, as their fingers rapidly traverse the keyboard, executing dozens of buy and sell orders per hour. If you believe what you read, day traders have turned Net stocks into acrobats, perched tippy-toe-like on dizzyingly high valuations.
In reality, though, the day traders' effect on Net stocks is much hype as fact. A close look at stock ownership figures shows that institutional investors have climbed aboard the Net train and now have just as much impact on the long-term pricing of these securities as individual investors. While day traders may be primarily responsible for the short-term volatility in Web stocks, increasingly, the big institutions are inflating the Internet balloon.
Just look at the ownership of Amazon.com, one of the premier Net stocks. At the end of March, 1998, mutual funds owned 2,562,000 shares of Amazon, according to mutual-fund research firm Morningstar. By the end of March, 1999, mutual funds owned 4.5 million shares of Amazon, an increase of 75%. Mutual-fund managers are being joined by pension funds, insurance companies, and banks. "There are a considerable number of serious institutional investors putting real money into the Internet space," says Keith Mullins, an emerging growth equity strategist at Salomon Smith Barney. "They've simply decided to commit intellectual suicide regarding the group's valuations."
TRUE BELIEVERS. Of course, those who got on board early -- when the rationale for buying Web stocks was murky -- have profited handsomely. In 1997, Amazon.com posted fourth-quarter revenues of $66 million and was sitting at $13, after adjustments for splits. In the fourth quarter of 1998, the company raked in more than $250 million in sales. And the stock now costs $117.50, an 800%-plus increase -- even though the company is nowhere near profitability, and doesn't expect to be anytime soon.
The original investors in these stocks were the true believers: Not only day traders, but grandmothers, schoolteachers, and aerobics instructors who opened accounts with online brokerages. As recently as a year ago, institutional investors smirked at these misguided souls.
Today, they can't join them fast enough. According to Vickers Stock Research, a basket of five Net companies (Amazon.com, CMGI, E*Trade Group, Network Solutions, and Yahoo!) have an average institutional ownership of 39%. While that's far below the average institutional stake of 63% in the S&P 500, the figure rises when you calculate it as a percentage of the shares available. When you subtract the insider ownership of these companies -- 25%, on average -- plus the number of these shares that are tied up in covering short sales (9%), institutional ownership of the Internet company shares that are actually available for trading on the open market rises to 59%. The comparable number for the S&P 500 is 65%.
FEW BLOCKS. "It's clear that institutions have really invested in the Internet," says Credit Suisse First Boston analyst Bill Burnham. "A lot of managers are being dragged, kicking and screaming, to Net stocks because if they don't participate, they will underperform their [market] indices."
Where does that leave the day traders? Basically, in control of short-term volatility -- Net stocks are twice as volatile as the general market. "Institutions are accounting for more ownership in Net stocks, but individuals are primarily responsible for the velocity of trading," says Alexander Cheung, manager of Monument Internet Fund. Indeed, despite high turnover in Net stocks, only in rare instances do block trades (of 10,000 shares or more) amount to more than 5% of their overall volume. That means that much of the volume is being executed by individuals, who typically can't afford 10,000 shares of anything.
Ultimately, of course, valuation levels of Net stocks -- like those of stocks in general -- are influenced more by long-term holders than by short-term traders. So it's the flood of institutional money into Net stocks that may help keep them at stratospheric levels.
Jaffe writes about the markets for Business Week Online
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