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Strategies & Market Trends : MDA - Market Direction Analysis -- Ignore unavailable to you. Want to Upgrade?

To: Les H who wrote (36854)	1/6/2000 3:47:00 PM
From: Les H	Respond to of 99985

Brother, Can You Sparadigm? Tech Stocks -- New Paradigm or Mania; by Troy Grice, Cales Investments 11:58 a.m. Jan 05, 2000 Eastern DENVER--(BUSINESS WIRE)--Jan. 5, 2000-- Tech Stocks -- New Paradigm or Mania By Troy Grice, Cales Investments (www.CalesInvestments.com) Is the tech stock buying frenzy rational or a speculative-mania? It's Irrational, Isn't It? Certainly no stock could ever really be worth 7,300 times its earnings could it? It's preposterous. It's irrational. Earnings determine value, don't they? Has the "greater fool" strategy supplanted "traditional" valuation methods such as price-to-earnings ratios, book value, and esoteric formulae crafted by ivory-tower academics named Gordon. The "greater fool" terminology stokes images of speculative bubbles like the one that afflicted those silly, 17th century Dutchmen who went snatching up tulip bulbs for the 1999 equivalent of $10,000 each. Are there lessons to be learned from the "tulipmania" which gripped Holland from 1634-37? Tulips saw a 5,900% run-up in prices in that 36-month span and the subsequent 93% correction created an economic calamity. Coincidentally, tulips, like tech stocks, don't pay quarterly dividends. But Maybe the Maniacs Aren't So Crazy Many tech-stock nay-bobs have used past speculative bubbles as grounds for dismissing the efficient markets hypothesis. They decry that employing a "greater fool" investment strategy is not rational. But their dismissal is founded upon a misunderstanding of rational behavior and, ultimately, efficient markets. Rational behavior doesn't mean anything other than any given human's desire to maximize his benefits by employing a strategy that uses all reasonably available information. There is nothing magical about the predictive power of efficient markets other than that they over and under predict outcomes equally. The goal of the investor (or the speculator or the tulip-bulb trader if you prefer that distinctions be made) is that of maximizing his risk-adjusted returns. Tell a tech-stock buyer (or a pre-1637 tulip-bulb buyer) that he has a 90% chance of doubling his money and only a 10% chance of losing it all, his eyes will light up with the sparkle of opportunity. Money that is earned from selling to a "greater fool" at a huge markup is just as green as money made via earnings driven price appreciation. The tech stock investor who employs the "greater fool" strategy is simply saying that he believes that the risk-adjusted, net-present-value of the cash flows from his investment will be greater than zero. If he believes that he has a 90% chance of earning a 100% return and a 10% chance of losing 100%, then his "rational expectation" is a return of 80% -- which is not too shabby. But to say that skyrocketing tech stock prices are purely the creation of greater fools blatantly ignores the fundamentals. Consider a tech stock with a share price of $234 and earnings of $.032/share (an actual example). If we required an annual return of 10.5% (roughly the market average over the last 30 years) then we could rationalize buying so long as we expect the selling price to be $385.50/share after five years. Assuming that the stock grew into its P/E with strong earnings growth (with the P/E falling to 100 after five years) then that would mean year five earnings of $3.86/share. The annual growth in earnings would be 161%. Is that really that absurd? The investor that believes that earnings will not significantly materialize is employing the "greater fool" strategy. But, who are the real fools? Tech-Stock investors or the one's standing on the sidelines? Is this a bubble or not? If it's so then it will surely burst. Tech stocks have crashed before -- losing over 80% of their value between 1968-70. It is entirely plausible (but not pre-ordained) that today's tech stocks could do something similar. Something like a dot com bankruptcy or a poorly timed rate hike might be just the pin that bursts the bubble for an entire genre of like-modeled tech-firms. But that's not the point. The point is that nobody, no matter how unfoolish, can possibly know when the bubble will burst. In the mean time, share prices keep skyrocketing and the nay-bobs keep predicting that the sky will fall. Therefore, one has to ask one's self how motivated they are by those wild tech-stock returns and how much risk are they willing to take in order to get them. Would you risk losing $5,000 if your odds are 50% that you'll turn it in to $9,200? How about a 10% chance at $50,000? If you could afford to lose it then you would only be a fool if you didn't make the investment. If you're ready to jump on the tech-stock bandwagon or if you prefer a more conservative investment approach Cales Investments can help craft a strategy specifically for you. Want to do it yourself? Check out our online trading at (www.CalesInvestments.com).