Sunday April 25 12:50 AM ET
Is Tide Turning Against Internet Stocks?
Full Coverage
Internet Stocks
By Pierre Belec
NEW YORK (Reuters) - Investors are still loading up on the money-making machine called ''The Internet,'' expecting that a bell will ring telling them it's time to race to the lifeboats.
The experts believe the tide may be turning against Internet stocks, which have been soaring for the last four years.
A study by a money managing firm shows that most of the top 10 Internet stocks are priced out of this world.
According to Dreman Value Management LLC, the large online auction house eBay Inc. is worth just $6 a share compared with its current price of $187, which has been inflated by optimistic expectations of the company's future earnings.
This week, Wall Street was reminded what could happen if the trendy stocks were ever caught in a severe downdraft. The 40-stock Dow Jones Internet Index Monday collapsed 19 percent, dragging the Internet-laced Nasdaq Composite index to its second-worst point loss ever, a bone rattling 138-point drop.
All of the Internet darlings were on the hit list, with America Online plunging $27 and Yahoo! tumbling $26. Internet-related companies in financial services also took a beating. E+Trade Group sank $19 and broker Charles Schwab, the biggest U.S. online broker, slumped $13.
But the Internets again showed they have a knack for creating inspirational rallies at low ebb. By the next day, the stocks were coming back in grand style.
Wall Street has become accustomed to the sector's craziness.
The average share of Internet stock that has come to market this year has rocketed more than 200 percent -- compared with a gain of just 2 percent for initial public offerings of stocks that are not in the Internet category, according to Renaissance Capital Corp., an IPO firm.
David Dreman, head of Jersey City, N.J.-based Dreman Value Management, which handles $7 billion of assets, said his study found that Internet stocks are simply an extraordinarily big bubble.
America Online, eBay, Yahoo!, Qwest Communications, Excite, Lycos, E+Trade, AmeriTrade, Amazon.com and Cisco Systems all went under the microscope in Dreman's analysis. But only Amazon.com and Cisco were judged to be close to reality.
Dreman said the difficulty in projecting the future of Internet companies is that many still do not have any earnings. The analysis got around that problem by relying on analysts' forecasts of what the companies could earn in their first year of profitability.
The analysis then projected a large 50 percent earnings growth for the companies in the first three years, followed by a 25 percent rise for the next five years, 20 percent for six years, 15 percent for seven years and a 7.5 percent income growth thereafter.
The results were mind boggling.
eBay, which has an incredible forward-looking price/earnings ratio of 8,600, was worth only $6 a share, compared with its current level of $187.
Yahoo! was given a theoretical value of $31 versus $189; America Online, $38 against $147; Qwest Communications $25 versus $92; Excite $54 compared with $152; Lycos $34 against $100; E+Trade Group $25 versus $104; AmeriTrade $36 versus the current level of $127.
Wall Street had reasonable expectations only for Amazon.com, which was calculated to be worth $103 versus its current level of $200, and Cisco, pegged at $118 versus $113.
''Any Internet companies would say that we're crazy and they'll earn much, much more, because, after all, this is a 'New World,''' Dreman said. ''But people have said the same thing about other speculative bubbles.''
Adding to the bullish excitement for the Internet sector are the estimated 7.5 million day traders.
''This has created problems not only for the stock market but for the day traders themselves, who suffer from a gambling problem,'' Dreman said.
''It's gotten so bad, that New Jersey has opened treatment centers for day traders with gambling addictions, just like they have places for people with casino gambling problems.''
William Valentine, investment manager at Valentine Ventures LLC said that the higher the Internet stocks rise, the more investors love the companies and the greater the demand for the shares.
''No one wants to miss out on the rally,'' he said. ''And the people who have not owned any of the stocks eventually get pulled into the market, thus creating a constantly expanding demand that Wall Street can't keep up with. ''
The biggest problem investors face is in figuring out which companies have the most potential. There is no model that would show, historically, which companies will end up to be winners or losers.
''There's not a lot of discrimination yet for Internet stocks and, as a result, the institutional investors are scrambling to get up the learning curve and they're buying chunks out of all of these companies,'' Valentine said.
When the ''Big Correction'' comes, however, people should not expect the Internet bubble to just burst.
''The bubble is more likely to deflate than burst because it will take time to bring the values of these stocks to what is reality,'' Valentine said.
Today's biggest names -- America Online, Amazon.com and Yahoo! -- will become powerhouses in the business, he said.
What will happen after the Internet shakeout?
''The blue-chip Internet (stocks) will gravitate toward more normal valuations, albeit high valuations,'' Valentine said. ''A whole bunch of secondary companies -- niche-oriented types that are trading 80 to 90 percent premium to what they are worth -- will suffer a more rapid sell-off.''
And, a third tier of Internets will become virtually worthless.
''That group, which is the vast majority of the Internet companies, will be consolidated and eaten up by the secondary stocks and blue-chip names, and they will essentially disappear,'' Valentine said.
Ironically, the companies in the third tier are the companies that Wall Street is advertising as the latest Internet hot stocks.
''They are the stocks that are coming to market right now and the Street is saying 'Hurry up, hurry up, the sun is up and the end of the day is coming,''' Valentine said.
''What's scary is that one-quarter of the Internet-related companies that are in the IPO pipeline are not only companies that have no earnings but they also don't have any revenues,'' he said.
Indeed, investors may just be buying a promise and a vision.
For the week, the Dow Jones industrial average was up 195.78 points at 10,689.67. The Nasdaq Composite index rose 106.65 to 2,590.69 and the Standard & Poor's 500 index gained 37.85 at 1,356.85.
(Questions or comments can be addressed to Pierre.Belec(at)Reuters.Com)
--------------------------------------------------------------------------------
|
