The return of Mr. Bubble
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Commentary: Don't get caught in the Net
By Bambi Francisco, CBS.MarketWatch.com
Last Update: 12:04 AM ET June 2, 2003
SAN FRANCISCO (CBS.MW) -- If you're getting seduced by this Internet rally, heed this caveat: The more people who become excited about Internet stocks, the fewer fools there will be to sell to.
And, you don't want to be the last fool. Too many people on the periphery of what's going on in the consumer Internet sector are beginning to feel nervous that they're missing the market rally.
That's momentum at work, not calls made on value or sound investing. Those calls were made at the start of the year, if not last October.
Here's my anecdotal evidence. A friend who had left working for a consumer Internet company and was disgusted with Internet stocks suggested to me last week that Internet stocks were ripe for investing. She said it as though she was ahead of the curve. A former Internet start-up entrepreneur echoed the same thoughts a month ago.
Even scarier, my e-mail box is beginning to get filled with messages from the same readers I heard from during the boom-boom years. Just last week, a reader wrote: "I'm back."
He's not the only one.
To be sure, some surviving Internet companies are real businesses that are growing revenue and profit while seeing a long path of market opportunity ahead of them.
The U.S. Census Bureau's newly published numbers showed that e-commerce sales by wholesalers grew 13 percent in 2001 while their overall sales were flat.
According to the Census Bureau, 10 percent of merchant wholesales are being conducted online. EBay (EBAY: news, chart, profile) is growing earnings 69 percent to $1.47 a share this year. They're expected to grow a further 41 percent in 2004. How many companies are growing earnings at that rapid clip?
This is why investors are willing to pay 100 times earnings, or two times EBay's growth rate. That's why they're willing to pay the high multiples for Yahoo (YHOO: news, chart, profile), Amazon.com (AMZN: news, chart, profile), and USA Interactive(USAI: news, chart, profile). And, that's why some investors are beginning to pay higher multiples for tiny Internet companies as well.
Some of these smaller companies have benefited so much from the euphoria for Internet stocks that their market caps have crossed thresholds at which they can now be considered part of the Russell 2000. Among those stocks are Ask Jeeves (ASKJ: news, chart, profile), E-Loan (EELN: news, chart, profile), and TheStreet.com (TSCM: news, chart, profile).
But investors need to keep in mind is what's missing and what's driving the stocks higher.
What's missing is a lack of insider buying, and the guarantee of a second-half recovery and sustainable refinance boom that's helping fuel consumer buying.
What is happening is a surge of insider selling. George Muzea, President of Muzea Insider Consulting Services, has noted in CBS MarketWatch columns that insider selling has been ratcheting up since April.
More disturbing is that sentiment is high. When insiders overall are selling, and the majority of sentiment measures is increasingly bullish, the scenario is ripe for the Nasdaq to unravel and re-test its October lows.
Recently, Muzea put yet another negative call on LookSmart (LOOK: news, chart, profile) regarding recent insider sales.
In addition, short covering has to some extent fired up some of the recent darlings. Short interest in Amazon.com in March, right before the Nasdaq rally, had reached its highest level since last November.
In mid-March, Ebay's short interest was the highest since last September. When the shorts cover their positions, they drive prices higher, leading some unsuspecting investors to believe the rally is driven by fundamentals.
Now, the shorts are piling on again, which means they could cause another short-squeeze rally, or it could be that they'll be right. As of mid-May, the short interest on Ask Jeeves was 27 times higher than it was in January. The short interest on DoubleClick (DCLK: news, chart, profile) in mid-May was the highest since July 2002.
Now, the momentum players and fund managers seeking to put money to work may force the market to go their way. And that could drive these stocks higher throughout the summer.
The recent rally appears strong from a technical standpoint. The rally may even last until the fall, according to Merrill Lynch. This rally can last six to 12 months, according to the investment bank. Moreover, the money flowing into the stock funds also suggests that fund managers will have more money to put to work.
According to Bank of America Securities, two weeks ago (week ending May 23) $1.7 billion of money flowed into domestic equity mutual funds, representing the 10th consecutive week where new purchases outstripped redemptions.
Another bullish factor is that with interest rates low, higher multiples can be justified.
But you have to ask yourself what kind of an investor you are. Are you a momentum investor with a trading mentality? If so, then put on that trader's cap. If you're going long now, buy some out-of-the-money puts for the same stocks, just as insurance, because when these stocks fall, they fall hard. Look no further than LookSmart.com, which saw its shares get clipped by 40 percent in one day.
Earlier this year, USA Interactive's (USAI: news, chart, profile) Hotels.com saw shares traded at $59 and drop to $40 on concerns that price wars in the hotel industry would hurt margins.
If you can stomach that volatility, then get in. But if you're patient, you'll buy when everyone is selling.
If history is any guide, any hint of bad news will cause an exaggerated decline, which provides a better entry point.
For now, study the Internet sector and these companies because they truly are beneficiaries of the massive spending and building out of the Internet infrastructure.
But don't get lulled into being the last fool.
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Bambi Francisco is Internet editor of CBS.MarketWatch.com, based in San Francisco.
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