December 30, 1998
There's No Mania Like Net Mania;
Historically, This May Take the Cake
By GREG IP
Staff Reporter of THE WALL STREET JOURNAL
The U.S. has seen stock manias before, but nothing, it would appear, on the scale of the current frenzy for Internet stocks.
The magnitude of Internet stocks' price increases and market values dwarfs what some longtime market watchers recall in previous speculative frenzies, like that for biotechnology stocks in 1991. And compared with America Online's trailing price-earnings ratio of 418, the 95-times-earnings Polaroid hit in 1972 at the peak of the "Nifty Fifty" era was a model of value investing.
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"If you were looking for something that was a fitting finale to the biggest bull market in history, it would be the biggest speculative mania in history -- and that's what it does look like," says Robert Farrell, senior investment adviser at Merrill Lynch.
A veteran market analyst, Mr. Farrell recalls similar crazes for franchise and computer-leasing companies in 1968, and for bowling stocks in 1961.
"The big public participation and parabolic price rises, the initial public offerings going up more than any other IPOs have on the first day of trading -- that kind of thing has happened before. The only difference is the extent and size of it. These stocks are getting to be worth more than many of the old-line blue chips."
For example, at its record close Monday of $157.25, America Online had a market value of $72 billion, which would have ranked it 33rd largest in the Standard & Poor's 500-stock index, to which it will be added at Thursday's close. That's bigger than PepsiCo, Gillette or General Motors. (Tuesday, AOL's value slipped to $70.8 billion.) Yahoo would have ranked 84th, while Amazon.com would have been No. 118. All three declined Tuesday while the S&P 500 rose, depressing their rankings.
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The Company That They Keep The Biggest Internet Stocks...
Market Cap (billions) Revenue-a (billions)
America Online $70.8 $2.90
Yahoo! 26.6 0.15
Amazon.com 17.5 0.42
eBay 11.0 --
AtHome 9.6 0.03
Network Associates 8.2 0.82
Netscape Comm. 6.6 0.57
E*Trade Group 3.3 0.20
CMGI 2.9 0.11
Excite 2.5 0.12
...Rival the Size of Old Standards
Market Cap (billions) Revenue-a (billions)
Walt Disney $62.4 $23.0
Colgate 27.5 9.0
J.P. Morgan 18.5 19.0
J.C. Penney 12.4 31.0
RJR Nabisco 9.5 17.0
Gateway 8.0 7.1
New York Times 6.6 2.9
A.G. Edwards 3.3 2.2
American Greetings 2.8 2.2
B.F. Goodrich 2.5 3.8
a-Latest 12 months
Source: Baseline, WSJ research
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Shares of eBay, which had revenue of $12.9 million in the company's third-quarter report, its first after going public Sept. 23, have a market value of $11 billion, exceeding Federated Department Stores, with third-quarter revenue of $3.6 billion.
"I know of no new-issue market that has exploded on the scene with this degree of intensity," says Jeremy Siegel, a professor of finance at the Wharton School and a renowned markets scholar. He says buyers of the stocks must believe not only that the Internet is as revolutionary as the telephone or telegraph, but also that any future profits won't be lost to competition. "That's where a lot of us have problems," Prof. Siegel said. "We're not denying the revolutionary aspect of the Internet."
Except for some high-profile analysts, most of Wall Street is skeptical of the Internet craze. Mr. Farrell says that at year-end luncheons, a regular recommendation is to sell "short" an Internet stock. (Short sellers hope to profit from a decline in a stock's price.) Individual investors appear to have far more faith.
These professionals aren't skeptical so much about the value of the Internet or that some companies will make a fortune on it. Rather, they are skeptical that so many companies can hope to survive, let alone meet the expectations built into their stock prices.
"Survivability, not valuation, is the key issue," Edward Kerschner, investment strategist at PaineWebber, wrote in a May report. He drew parallels between Internet stocks and personal-computer stocks, darlings of the 1982-83 bull market. At the end of 1982, the most-prominent PC makers were Apple Computer, International Business Machines, Atari, Commodore, Tandy and Texas Instruments. Only Apple "was a good long-term vehicle" for playing the PCs business, and most of today's leaders -- Compaq Computer, Dell Computer or Gateway -- weren't even public at the time.
The best parallel to the Internet mania was the craze of biotechnology stocks in 1991-92. These were companies that similarly rarely had revenue, let alone earnings, and therefore defied standard valuation efforts. According to Securities Data Co., 101 biotech companies went public in 1991 and 1992, raising $4.4 billion. Only 44 are still trading.
By comparison, Securities Data counts 73 Internet companies that have gone public since the beginning of 1997, raising $4.6 billion. (AOL and Yahoo have been public for more than two years.)
But by one measure, the Internet mania has been far more intense: Internet shares have gained an average of 38% on their first day of trading, compared with the 7.5% average for biotech companies, Securities Data calculates.
One lesson of the biotech and other technology manias, Mr. Kerschner wrote, is that "too much will be paid for even the best companies." He noted that Amgen, the leader of the biotech group, didn't sustainably break its end-of-1991 level until 1995. (In an eerie parallel to America Online, Amgen entered the S&P 500 on the last day of 1991.) "Amgen was a great company but an overpriced stock."
Even if AOL's per-share operating profit was to grow 50% a year for the next five years, investors are now paying 55 times those five-years-out earnings. But that might be justified if it survives an industry shakeout that vanquishes dozens of competitors.
"At current valuations, I can't say AOL is a good buy," says Aash Shah, a fund manager at Federated Investors. "But AOL will be one of the long-term successes within the Internet space."
Prof. Siegel notes that many investors doubted IBM could sustain its double-digit earnings growth in the 1960s. Skeptical investors were reluctant to pay the high price its stock consistently commanded relative to earnings -- thus passing up one of the most impressive companies of the era. "There are arguments ... these growth premiums might have some justification," says Prof. Siegel.
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