The Internet-Stock Bubble
The stock market is
certainly reacting faster than ever to the slightest hint of good or bad news.
Whether this means the stock market is more efficient than ever, though, is
another question entirely. The answer may depend on whether you think
"efficient" is a synonym for "jumpy and hysterical."
As
Exhibit A, we offer the recent trials and tribulations of the so-called
Internet stocks, trials and tribulations that said less about the actual
business of the Internet than about the manic behavior of Wall Street in a
just-won't-quit bull market. This most recent hysteria saw investors pouring
billions of dollars into Internet stocks before suddenly--and all at
once--changing their collective mind and racing for the exit. In this they
resembled nothing so much as the knights in Monty Python and the Holy
Grail , who took comfort in screaming "Run away! Run away!" as they fled
killer rabbits and the like.
The ride began rather oddly, when some of the most
prominent makers of computer hardware--memory chips, microprocessors, and
PCs--announced that their earnings for the first quarter would fall short of
the all-knowing analysts' estimates. Intel, Compaq, and Motorola all said that
slowing demand--both in Asia and at home--was hurting profits, and both Intel
and Compaq emphasized the negative impact of sharp cuts in PC prices. The bad
news crushed these stocks, but much of the money that left Intel and Compaq
immediately flooded into companies such as Yahoo!, Amazon.com, and myriad other
search engines, online retailers, and Internet access providers whose listings
now dot NASDAQ.
In part,
that move into Internet stocks is simply evidence of what happens when everyone
believes so strongly in the stock market that keeping any money in cash is
regarded as heresy. In other words, if you were a mutual fund manager, you
couldn't very well sell Intel and then say, "Now I believe I will wait until I
can find a company that seems fairly valued." If you did that, you might miss
out on the latest rally. The money had to go somewhere, and when Net stocks
became the Next Big Thing (for those few days), that's where the money
went.
Still, there was a certain logic at work in
making Net stocks the Next Big Thing. If PCs are getting cheaper and cheaper,
then more people will buy them. If more people have PCs, then more people will
eventually use the Internet (fewer than 20 percent of U.S. households currently
have access). This in turn means that more people will search on Yahoo!, buy
books from Amazon.com, and so on. But while the long-run implications of cheap
PCs for the Internet are important, it's hard to see how Intel's profit
concerns made Amazon.com $500 million more valuable last Tuesday morning than
it was the Friday before. The same was true of all other Internet companies
whose option-holding executives must have been thanking their personal deities
for the Asian crisis. It was a classic case of the next five years of good news
for a company being priced into its stock all at once. And then the worm
turned.
Why it
turned isn't really clear, but it definitely did. It was a very odd thing to
watch, in fact. Sometime midmorning last Tuesday, the Net stocks peaked, then
tumbled even more quickly than they had ascended. Amazon.com, Yahoo!, Excite,
Lycos, EarthLink, MindSpring: All lost between 10 percent and 15 percent of
their value in just a few hours. Apparently, the cheap-PC theory had a few
holes in it.
Just as the shift of money into Internet stocks was partly
the product of a virtuous circle created by institutions trying to keep their
portfolios invested in stocks that had "momentum," so too was the shift out
partly the product of a vicious circle created by institutions trying to dump
stocks that suddenly didn't have momentum. The rout also had something to do
with the fact that only a few Internet companies have ever reported profits and
that even those that have profits trade at valuations to which, as they say, no
traditional criteria can be applied. Everyone knows that you can't value these
companies the way you'd value General Electric (perhaps because if you did
these companies would all have stock prices that are one-eightieth of what they
are now). But every so often the market does look at their bottom lines, and it
finds that discretion is sometimes the better part of valor.
Still, the
most dubious part of this little minidrama is not really investors' herdlike
advance and retreat as much as it is the governing principle behind that
herdlike behavior. That governing principle is that all these companies belong
to something called "the Internet sector" and that it's the sector, and not the
companies, that matters. This is, of course, the principle governing most
institutional investing, which is why pharmaceutical stocks and airline stocks
and semiconductor stocks tend to move as groups. It's a rare day when American
Airlines' stock rises while other airline stocks fall. There is the kernel of a
good idea at work here, namely that macroeconomic or external events--like,
say, a fall in the price of gasoline--that help one company in an industry will
also help others. But sector investing also tends to reward a successful
corporation's competitors for that corporation's success, and in that sense
seems not merely counterintuitive but downright perverse.
More to the point, in the case of the Internet,
sector investing rests upon a basic misconception, namely that there are things
we can meaningfully call "Internet stocks." In fact, there are at least five
different types of Internet companies, each of which has very different future
prospects. Online retailers, such as Amazon.com and music seller CDnow, are
still selling into a tiny market but one that's growing explosively. Search
engines, such as Yahoo! and Lycos, are evolving into what are called "portal"
sites, hoping to become more like mini-AOLs than just search engines.
Infrastructure companies, such as VeriSign, Verity, and Netscape, are creating
the tools that make the Web work, but their main source of income will come
from corporations. A few companies, most notably CNET, are trying to make money
packaging content. And, finally, there are the Internet access providers, which
is to say, America Online and everybody else.
To be sure, all these
companies will benefit from having more people use the Internet. But not all
will benefit equally. And even within those five groups the differences among
individual companies are more important than the similarities. To put it a
different way, Amazon.com, Yahoo!, and AOL, which have established tremendous
brand recognition and clear business models, have more in common with each
other than Amazon.com does with other online retailers or AOL with other access
providers. And yet the strength of these companies--each, by the way, now
valued at stratospheric heights--is helping carry those around them. The
Internet will undoubtedly be a crucial part of the economy of the next century.
But Wall Street would be better off remembering that approximately 12,000 auto
companies were around in the early part of this century. Instead of mindlessly
tossing billions at or taking billions from the Net as such, investors should
be spending their time making sure that it's the future Fords and General
Motors of cyberspace that are getting the capital they need.
