Warnings Or Opportunities
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Warnings Or Opportunities?
By Marc H. Gerstein
March 1, 2000
Here's a selection of internet companies with relatively healthy business fundamentals whose shares have been lackluster compared to other net issues. Do the price trends present warnings or opportunities?
Beyond The Headlines And Cliches
Sometimes, it seems as if the information explosion has a downside. Last week I attended a professional association presentation on the topic of risk measurement. I don't recall how the topic of internet stocks came up, but someone quipped that the speaker would have to adjust his methodology to account for this group. Otherwise, the calculations would be distorted by the fact that "internet stocks never go down."
Obviously, the remark was offered as a joke and everyone took it that way. But sometimes, I wonder if the line between kidding around and reality gets a bit too blurry. For a while now, we've been bombarded, day after day it seems, with headlines about the powerful performance of the NASDAQ stocks, led by technology and internet.
Let's step back a moment and take a more detailed look at what's been happening in the past month.
The NASDAQ that the journalists speak of is not the stock market. It's just an index based on specific stocks and calculated in a specific manner (weighted by market capitalization). Among the 4,709 stocks in the Market Guide database that trade in the NASDAQ system, 2,105 are down in price over the past four weeks.
When talking of strength in the NASDAQ, journalists often credit technology and internet. I can't argue with the technology angle; among the 1,442 NASDAQ issues that are classified as Technology, 935 (65% of the total) are up in price over the past four weeks, and 748 issues (52% of the total) are up more than 10% (which is pretty good for just four weeks).
When commentators credit internet stocks as a force behind the NASDAQ's strength, the picture becomes murkier. This week, Market Guide's internet database contains 643 stocks. Of that group, 505 trade in the NASDAQ system. And only 228 out of the 505 NASDAQ internet stocks are up in the past four weeks. (And only 339 stocks out of the full 643-stock internet group are up over that span.)
Obviously, NASDAQ stocks and internet stocks can and do go down.
Good News Or Bad News?
What should we think about an internet stock that struggles? Should we take it as an indication that something is wrong with the company. After all, we know that it's characteristic of a newly emerging business sector that not all pioneers survive over the long haul. Is the market already starting to separate the wheat from the chaff among internet firms?
On the other hand, many who live with the market day after day believe it's not nearly as "efficient" as academicians often like to claim. However hard the investment community tries, plenty of good things always fall through the cracks. And at times, investors, even professional investors, can draw incorrect conclusions from known facts.
Getting back to the original question, should we interpret lagging share price performance in the internet sector as a warning of possible trouble for the companies, or a buying opportunity. Answer: Both of the above.
Actually, this non-answer should be very familiar to most experienced investors. After all, that's the way you should react to stock price weakness in any sector of the market. In other words, as is the case with other kinds of stocks, bad price patterns for internet stocks should be seen, not as providing answers, but as a signal that a closer look is required.
Stock Screening
Data screening alone can't tell you everything you need to know about underachieving internet stocks. But as is the case with others, the screening process can be a tremendous help in narrowing your list to a manageable number of situations. This is accomplished by identifying lagging stocks, and then searching for clues that suggest positive company fundamentals. These are the situations in which depressed (relative to the internet group) stock prices are more likely to represent opportunities than warnings. (Remember, though, that this is a starting point. Company-by-company review is still necessary.)
Here's how this particular screen was constructed.
Share Price Performance: I start by looking for internet stocks that rose less than 125% over the past 26 weeks, that being the approximate market capitalization weighted price gain for the group as a whole. I narrowed the list further by also seeking shares that fell in price over the past four weeks.
Growth: In seeking favorable business fundamentals, I start with sales growth. And instead of focusing on year to year growth (in which a December 1999 reporting period would be compared with a December 1998 interval), I look at the more stringent consecutive-quarter comparisons (in which December 1999 performance is compared with September 1999 results). The capitalization weighted consecutive quarter sales growth average for internet companies is about 22%. The screen searched for companies that grew more quickly in the latest period for which data is available.
Realistically, it's hard to maintain 22% consecutive quarter growth for a long period. To give you an idea of how rapid this growth rate really is, here's an example showing what a company's sales would look like if it started at 100 and logged 22% consecutive quarter sales growth over a two year period.
Year 1 Year 2
Quarter 1 100.0 221.5
Quarter 2 122.0 270.3
Quarter 3 148.8 329.7
Quarter 4 181.6 402.3
Total 552.4 1,223.8
We see that the annual growth from year 1 to year 2 amounts to 121.5%.
Financial Liquidity: Among internet stocks an important indicator of fundamental health is positive cash flow, or at least enough cash on hand to cover outflows for a reasonable time into the future. So the screen requires companies with negative free cash flow in the latest quarter to have cash and cash equivalents that exceed the latest outflow multiplied by four. (In other words, at the present rate of "cash burn," the companies have enough on hand to get through another year without need for more outside capital.
Institutional Ownership: The screen requires that institutional ownership of the stock be less than 37%. On balance, institutional ownership in this sector is lighter than for the market as a whole. But it's not as light as those who mutter cliches about day traders would have you believe. The market capitalization weighted average level of ownership is about 37%. By adding below-average institutional ownership to the mix of weak stock prices and good fundamentals, we enhance the probability that the market weakness reflects falling through the cracks, as opposed to serious worries. (But again, and I can't emphasize this enough, this is a starting point for further study; not a final answer.)
The screen uncovered 57 issues, all of which are included in the accompanying Excel spreadsheet. The table below lists the top 30 companies in terms of consecutive-quarter sales growth.
1. Download an Excel spreadsheet (42K) for all 57 stocks in this screen.
2. Download an Excel spreadsheet (424K) showing comprehensive data for all 643 internet stocks.
Ticker Company Internet Group Sales % Growth
From Prior Quarter
ROWE Rowecom Inc. E-Commerce 3,006.30
PASA quepasa.com, Inc. New Media 1,500.00
NTVN Netivation.Com, Inc. New Media 804.17
TLTG Teltran International Gr. Infrastructure 396.73
LOAX Log On America, Inc. Services 388.98
HITS Musicmaker.com, Inc. E-Commerce 293.75
MPPP MP3.com, Inc. New Media 276.94
CYBA CyBear, Inc. Software 237.04
AHWY audiohighway.com New Media 146.18
ALOY Alloy Online, Inc. E-Commerce 139.45
ELNK EarthLink Network, Inc. Services 122.32
SALN Salon.com New Media 118.87
FLWS 1-800-FLOWERS.COM E-Commerce 104.46
DCTI Digital Courier Tech. E-Commerce 103.91
ASTN Ashton Technology Group Software 90.26
TURF iTurf Inc. New Media 79.57
PRSW Persistence Software Software 79.35
NBCI NBC Internet, Inc New Media 75.06
ASKJ Ask Jeeves, Inc. New Media 68.97
BNBN barnesandnoble.com inc. E-Commerce 67.45
NXCD NextCard, Inc. E-Commerce 66.67
MCNS Mediconsult.com, Inc. New Media 64.92
WGAT WorldGate Communications Services 64.70
TCTY Talk City, Inc. New Media 64.17
SGNT Sagent Technology, Inc. Software 62.48
VUSA Value America Inc. E-Commerce 60.97
GOTO GoTo.com, Inc. New Media 57.78
EELN E-LOAN, Inc. E-Commerce 53.36
NSPK NetSpeak Corporation Software 53.03
DSCM Drugstore.com, Inc. E-Commerce 52.06 |
