Internet Stocks: A Rerun of the Biotech Craze?
A fledgling industry with seemingly limitless
potential captures the imagination of the press
and investing public alike. Stock prices triple,
quadruple or even quintuple in a matter of
months. New issues more than double in their
first day of trading. All this despite the fact that
few companies in the sector have recorded a
profit.
Sounds like Internet stocks, 1997 to 1999,
right? Nope. Try biotech stocks, 1990 to 1992.
In less than two years of biotech mania, the
average stock in the sector rose nearly 500
percent.1 Remarkably, the Internet boom has
proved even more explosive. From its April
1997 low to its April 1999 high, the CBOE
Internet Index (a respected measure of industry
stocks) rose 659 percent.2
The biotech bubble burst after soaring for two
years, however, and prices plummeted. The
sector's speedy rise and fall has caused some
of today's investors to wonder if Internet stocks
may suffer the same fate.
The two sectors do share some
characteristics, including the explosive growth
cited above and a lack of hard quantitative
yardsticks ? like P/E (price/earnings) ratios
? traditionally used to measure companies'
progress. But there are also crucial differences
between the biotechs and Internet stocks.
Some of these differences suggest that
Internet stocks may fare better, while others
argue for caution. Before considering
purchasing stocks in any sector, consult with
your financial advisor to make sure they fit
within your long-term investment goals and
your tolerance for risk.
Bullish factors for Internet stocks
?
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Earlier profitability. Because biotech
firms face difficult regulatory hurdles and
long product-development cycles, Internet
companies may reach profitability faster
than biotechs.
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Internet firms may face fewer obstacles
than biotechs. They employ fewer workers,
have less in the way of hard assets and
often carry little or no inventory. While
most Internet companies have yet to show
a profit, they can attain global reach with
relatively low overhead, so profitability may
come more quickly. One of the first major
Internet companies to turn a profit was
eBay ? an online auction service that
carries no inventory, but simply earns
commissions when others sell their
merchandise via its Web site.
?
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Healthy skepticism. At the peak of the
biotech boom, the industry attracted scant
attention ? positive or negative ? in the
popular press. The January 1992 issue of
Money magazine highlighted a biotech
fund as the best-performing mutual fund of
1991;3 however, the article included no
warnings about high valuations in the
biotech sector.
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Today, popular magazines are shouting
about the "Internet bubble," the theory that
Internet stocks are in a classic manic
phase and are bound to crash. In 1998 and
1999, Fortune, Business Week, the
Economist and U.S. News and World
Report have all run cautionary cover
stories.
Bearish factors for Internet stocks
?
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No barriers to competition. Jim
McCamant, editor of the Medical
Technology Stock Letter, points out a flip
side to the problem of long development
cycles and regulatory processes for
biotech products: patent protection.4
Because it's expensive to compete in the
industry, leading companies may be able
to build a nearly impenetrable barrier to
entry, resulting in minimal competition for
years.
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Most Internet firms lack such protection.
Their services aren't based on crucial
proprietary technology, making it easy for
competitors to emerge and cut into a firm's
revenues. eBay's early success attracted
dozens of competitors, including online
powerhouse Amazon.com, to the auction
market. And Amazon.com itself, which
pioneered online bookselling, is now
caught in a price war with major
competitors like Barnes and Noble and
Borders.
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Market values. At their peak in January
1992, the biotechs had a combined market
value of $60 billion to $70 billion. That's
less than today's market value for America
Online alone.5 The overall market value of
the Internet sector runs into the hundreds
of billions of dollars. High market values,
without the support of current earnings,
can leave a lot of room for price declines if
future earnings do not materialize as
quickly as expected.
Biotechs after the peak
How did the biotechs fare after they peaked in
early 1992? The sizzle quickly turned to fizzle,
and they entered a 30-month bear market. The
AMEX Biotech Index, which stood at 256.60 in
January 1992, closed at 72.46 on July 29,
1994 ? down 72 percent.
However, summer 1994 turned out to be a solid
buying opportunity. As of July 1, 1999, the
AMEX Biotech Index stood above 220 ? three
times higher than it was five years before.6
Today, although biotechs as a group are worth
about $100 billion, most major indices are still
below their 1992 peaks. But the industry is
showing fundamental promise, says
McCamant. While only 15 to 20 (out of more
than 300) companies are profitable as of
February 1999, many more are close to turning
the corner.7
Investing in biotechs has taken patience, and
the sector may yet reward long-term investors
who ignored the initial frenzy and waited for
prices to return to reasonable levels. Investors
interested in Internet stocks may be well
advised to exercise similar restraint. |
