November 22, 1998
From the New York Times
Flights of Fancy in Internet Stocks
By SAUL HANSELL
t was a sunny afternoon in Tucson last March when Mary Meeker sprinted past a cluster of computer
executives chatting at PC Forum, an annual gathering of the digirati. Ms. Meeker, an analyst at
Morgan Stanley Dean Witter, is best known for her coverage of Internet companies.
"Mary, would you sell Yahoo when it hits $5 billion?," a reporter shouted
from the crowd. Yahoo, the top-rated site that guides people to destinations
on the World Wide Web, had already become the darling stock of
high-technology investors. Despite tiny sales and microscopic profits, it had
surged to a total market value of $4 billion.
Ms. Meeker paused, looking quizzical.
The reporter pressed ahead. "How about $10 billion?" he asked.
"No," she said.
Then, throwing out a value that would have seemed unthinkable at the time,
he barked, "$20 billion?"
"If I believe in the company, I buy the stock," she answered, impatient with
the question. Then she zoomed off.
So, too, would Yahoo's stock market value. It shot past $5 billion in April,
hopped over $10 billion in September and is now at $18.8 billion. And Ms.
Meeker, like most of the other analysts who follow the stock, continues to rate
Yahoo a strong buy.
Almost every type of investor thinks about valuation in one way or another.
The trick of the game, after all, is to buy low and sell high -- and that
requires a way to measure if a stock price is more or less than it should be.
But analysts and investors who are bullish on companies like Yahoo -- or on other new stars like
Amazon.com, the bookseller, and Ebay, the on-line auctioneer -- are just not interested in the question of
whether these stocks are climbing too high.
If you have to ask, as they say on the Internet, you just don't get it.
"If we had been overly focused on value, I don't think we would have been able to take the leap of faith to
own these things," said Pamela Cutrell, a vice president of Essex Investment Management, one of the few
institutional investors that have been active in Internet stocks.
Ms. Cutrell argues that Internet companies are growing so fast that they are bound to become more
valuable.
Of course, many investors who focus on the value question washed their hands of Internet companies long
ago -- if they ever sullied them in the sector to begin with. Indeed, that has been the style of professional
investors.
"These are not pension fund-type stocks," said Shaun G. Andrikopoulos, an analyst with BT Alex Brown.
Most trading in such issues is in lots of a few hundred shares, indicating that individual investors, not
mutual funds or other institutional investors, are the usual players.
Of course, brokerage firms and their analysts cannot simply wash their hands of these stocks, no matter
how unreasonable the valuations may seem. There is too much money to be made in underwriting the
stock offerings of the endless stream of Internet companies.
Some analysts justify their recomendations with the multiple-multiplication method. In this approach, the
analyst forecasts continued, rapid growth for sales, and just maybe earnings, for the company for several
years. Then the analyst calculates what the stock would be worth if the company achieved those sales
forecasts and its stock traded at a certain, enormous multiple.
A good example of this is the justification used two weeks ago by Rakesh Sood, the Goldman, Sachs
analyst, for a report predicting a $150 stock price within 18 months for Ebay, a company that Goldman
had brought public in September at $18 a share; it now trades at $147.
The analyst estimated that the revenue of Ebay, which lets consumers auction their attic collectibles, would
triple from $43 million to $126 million in 2000. If the company exceeded his published estimate by 50
percent ("Optimistic," he wrote, but hardly unthinkable) and it warranted a price-to-sales multiple of 35,
then its stock would be worth $150.
Others, however, don't bother with the mathematical contortions to back up their picks. "Never let
valuation get in the way of a good Internet story," Andrikopoulos said. "The only way to look at Internet
stocks is based purely with what is happening with the underlying fundamentals."
Andrikopoulos used to cover computer stocks, to which he applied the old-fashioned idea that analysts
should recommend selling stocks as they became over-valued. He learned his lesson with Yahoo's stock
when he downgraded it in June 1997. After the stock tripled, he upgraded it last April, and it has more
than tripled since. Now, Andrikopoulos has a buy recommendation on every Internet stock he covers.
One analyst who argues that some small measure of gravity may apply even on the Internet is Paul W.
Noglows of Hambrecht & Quist, the San Francisco brokerage firm that specializes in small companies.
After championing Yahoo for years, Noglows dropped his rating to a hold in July, after its market value
hit $10 billion.
"I love Yahoo on a fundamental basis," he said, "but I don't think its value should be the same as Viacom
or CBS." Viacom, he said, is expected to post revenue of $15 billion next year, versus $315 million for
Yahoo.
Noglows has become a virtual Jeremiah among Internet analysts because he dares to speak of value. His
initial rating for Broadcast.com, the on-line music and news provider, was a hold, a shocking move since
his firm was among the underwriters. "I am a huge believer that the Internet will dwarf anything we have
seen before," he said. "But I don't think that people are buying these stocks to hold for the next 10 years. I
think this is a game of the greater fool." |
