Why am I being a killjoy at the Internet party? Because prices of the so-called pure play Internet stocks are insanely high. Only mad optimists, professional investors or people with cast-iron stomachs should go near them. When it comes to tech companies like Intel or Micron or Motorola, you can make rational decisions based on a company’s stock price and prospects. But with Internet stocks, which have no meaningful histories, you’re buying dreams, hope and hype. Especially hype. You don’t need to know the Internet from a fish net to do the basic math that shows that if you overpay for the stock of even a very good company, it’s almost impossible for you to make a superior long-term profit. And long-term profit is what we small nonprofessional investors should worry about. You short-term types, find a different article to read.
The biggest stock we’re talking about is Netscape, the prime example of Internet Insanity. Then there are Spyglass, Uunet, Psinet and America Online, the other pure Internet plays. And who can resist poking Pixar, which did the animation for Disney’s “Toy Story.”? Pixar isn’t an Internet player, but like them, it’s a technology stock whose price is based on dreams Even if these companies do fabulously well, which most of them won’t, it’s hard to see how you can do fabulously well buying them at today’s prices.
It’s a question of numbers, not technology. Let’s say that you think that Netscape, which makes the Navigator Web browser, is the next Microsoft. After all, Netscape’s boosters say the company’s technology will let it dominate the Internet the way Microsoft’s disk operating system let it dominate the PC software market. At its closing price of $130.50 on Dec. 15–the date for all the prices in this article–Netscape sells at more than four times its offering price in August and at 10 times what it was willing to sell stock for early this summer
This huge run-up notwithstanding, you still think you can buy Netscape and become a junior Bill Gates. OK. Let’s see what it takes for a stock to become another Microsoft. If you bought 100 shares of Microsoft for $21 at its initial public offering in 1986, your $2,100 has become 1,800 shares currently worth almost $160,000. Pretty slick. But if you are to make a similar 75-to-1 profit in Netscape, the stock has to rise to almost $9,800 a share by the year-end of 2004. That would make Netscape the greatest success in the history of capitalism. Its 40.8 million shares (including stock under option;,as do all the valuations in this article) are already worth around $5.3 billion. Almost a billion dollars more than Apple Computer, but who’s counting? For you to make a Microsoft return starting now, Netscape shares have to be worth almost $400 billion in less than 10 years. How much is $400 billion? It’s more than seven times the current value of all the shares of Wal-Mart or Microsoft. Almost 13 Disneys. Almost as much as General Electric, Exxon, AT&T and Coca-Cola combined. You don’t need a doctorate in higher mathematics to see that’s sort of unlikely.
I’m being a little silly, of course, but I want you to see how the numbers work. And how hard it is to buy high and make out long term. Take Apple Computer, the world’s hottest technology company when it first sold stock torre public in 1980. If you bought 100 shares at the offering price 15 years ago and reinvested the cash dividends, your $2,200 has become 219 shares worth around $7,700. Look, Ma, a 250 percent profit–but it’s less than ,9 percent a year, compounded. The boring old Standard & Poor’s 500 earned almost 15 percent, with much less risk. Even before it tanked in December, Apple had underperformed the S&P.
Lest you think I’m picking on Netscape, let’s look at its major rival, Spyglass-an-other company whose investors are buying on faith, Both companies can’t be wildly successful, because they both make Web browsers and use essentially the same technology. Yet Spyglass has been hotter than Netscape. It sold stock at $17 in June. Nowit’s $93.25, valuing the whole company at 8500 million, up from $90 million. What changed? Not the reality of the company, but the market’s perception of the company. Is Spyglass worth 5.5 times what it was worth in June? No way. For Spyglass to produce a third of the Microsoft return, it has to be worth $12.5 billion before 2005 rolls around. Good luck.
The other companies–America Online, valued in the market at $4.5 billion; Uunet, $2 billion; Psinet, 81 billion, and Netcorn, $700 million–are Internet providers. They connect you to the Internet and may also provide information as well. But deep-pocketed phone companies like Bell Atlantic and Pacific Bell and long-distance companies like AT&T and MCI offer, or will soon offer, this service. Not to mention Rupert Murdoch’s News Corp. AOL, the biggest online company in the country, reports a profit. But the profit comes from accounting, not operations. It runs a cash deficit, and covers the shortfall by selling new stock. The others are all start-ups. Unless a phone company in heat pays up for one of these companies–after all, AT&T paid $7.5 billion for NCR, a mainframe-computer company–I can’t see holders making out in the long run.
And there’s Pixar. It sold stock to the public in November when the hype over “Toy Story” was at its peak. Pixar, run by Apple cofounder Steve Jobs, was originally willing to go public at $12 a share. Pixar peddled stock at 822, it soared to $49.50, and is now $23.75. If you bought at the peak, you’ve already had almost a 50 percent haircut. The hype centers on the firm’s deal with Disney. What’s the deal? Pixar filed its Disney contract with the SEC–with everything important marked out. Pixar says in a filing, though, that “Unless ‘Toy Story’ is an extraordinary box-office success at least as great as Disney’s ‘Pocahontas’ or ‘Beauty and the Beast’ with similar success in ancillary markets for the related products, Pixar’s compensation will not be significant.” You think this is worth $1.1 billion? The stock market does.
To be sure, plenty of securities analysts tout these stocks. Why am I so negative when people who are presumably better informed are so positive? Because analysts are paid largely on the business they create, and profit mightily from the stock-under-writing business they help bring in. Those are pretty good incentives to believe in fairy tales. The clearest sign that these shares are overvalued comes from the companies themselves, which have recently sold additional new shares. They hope to squirrel away cash to survive the inevitable market downturn, when they won’t be able to sell stock. The time to buy these things isn’t now, but when no one wants them. When they’re on newspaper front pages or magazine covers, look out below.
