The Epicenter – 8 April 1999
3
of the solar system. As with most trends, some industries and companies are
positioned to benefit from the revolution, others are positioned to get hammered
by it.
We recommend that diversified growth investors allocate a small percentage of
total capital to a basket of high-quality, direct internet investments (of which, in
our opinion, there are about 10 to 15). Underneath the internet sector's dizzying
valuations, in our opinion, are the foundations of what could become the early 21st
Century's leading growth companies—a group that we think could include one or
more of today's “big three”: AOL, Yahoo!, and Amazon.com. Much of the
capital in our model internet portfolio is concentrated in these three stocks, which
we consider the best proxies for the growth of three major internet revenue
streams—access, advertising, and commerce. The three companies have shown an
ability to manage extraordinary growth and, importantly, evolve along with the
industry, and they have management teams that appear to be motivated by much
more than money (namely, the chance to make history). Because the companies
have solid fundamentals, we believe that in the event of a sector correction, their
stocks will be among the least risky investments in the industry.
The “basket” approach allows investors to make a few disastrous individual
investments and still generate a compelling long-term rate of return. If you take
all of the pure-play internet companies in the public market and add them together,
you get about $150 billion in market capitalization—or about a third of a Microsoft.
We believe that over the next 5 to 10 years, the internet opportunity will result in the
creation of at least one Microsoft-sized company and maybe more (more on this in
future notes). The good news is that you don't have to pick out the Microsoft at this
stage of the game to make good money—you just have to make sure it's somewhere
in your portfolio. If, for example, you were to buy $100-worth of AOL, Yahoo!, and
Amazon.com today and two of them were to go to zero (we don't think they will)
while one became Microsoft, you would still get a good rate of return (if the
collective value of AOL, YHOO, and AMZN increased from $150 billion to
$500 billion in 7 years, the annual rate of return would be 19%; in 2006 your $300
investment would be worth $1,013 regardless of who won).
The overall internet stock phenomenon may well be a “bubble,” but in at least one
respect it is very different from other bubbles: there are great fundamental
reasons to own these stocks. Say what you will about their valuations, the leading
internet stocks are not “concepts”—and they are riding on meteoric fundamentals.
The companies underneath the stocks are 1) growing amazingly quickly, and
2) threatening the status quo in multiple sectors of the economy, a one-two punch
that many other famous “bubble” investments lacked. The rise and fall of the South
Sea Company's stock in 1720, for example (from 125 to 850 to 33 in six months), as
well as the rabid urge on the part of South Sea investors to finance thousands of
other dubious business plans (sound familiar?), was based on a fraudulent premise:
an inexhaustible supply of future riches to be transported to England from South
American gold and silver mines. Never mind that throughout the bubble, the alleged
riches were owned not by the South Sea Company, but by the King of Spain, who
had no intention of allowing anyone to ship them anywhere but Spain. The tulip
bulbs bought and sold during the “tulipomania” in the Netherlands in the 1600s had
no more inherent value or impact on the world economy than Furbies, Cabbage
Patch Kids, and Beanie-Babies do today. The biotech stocks of the early 1990s
promised a revolution in medicine and agriculture, but were true “concepts” that,
even if successful, were unlikely to affect many other industries. In our opinion, there
are good reasons for investors to pay through the nose for the leading internet stocks.
The internet stocks have always seemed absurdly expensive (and the valuations
are indeed eye-popping), but for several reasons we believe they are more
valuable than most people think. Stocks go up or down not because they are
trading at particular multiples of published projections but because, for a variety of
reasons, investors decide to buy or sell them. As implied above, we believe that
the leading internet stocks are “valuable” as portfolio investments for reasons that
Remember the adage about the
eggs and the basket.
“Bubble” or not, the internet
and e-commerce are
threatening the status quo, and
they are backed by
fundamentals. |
