Everybody says you can’t put a value on a human life. But a corporation? That used to be easy.
Investors just studied how much a company made, owned and owed.
Then came the Internet, which changed everything, as its boosters like to say. So have Internet companies, which often have high debt, few assets, little history and no profits.
Investors are rushing to pay hundreds of dollars a share for such firms. The old math doesn’t work anymore.
“I don’t know how you value these things,” said Dallas stockbroker David Johnson, expressing the uncertainty that is keeping many puzzled investors out of the hottest stock craze going. “It’s just a new set of rules. The Internet stocks are bizarre and outrageous.”
But as some stand aside, a new wave of investors is inventing its own bizarre and outrageous-seeming rules for attaching values to Internet stocks. The tech-smitten are studying such things as a firm’s total sales, number of customers and employment level.
Or even its losses. When Internet bookseller Amazon.com said Jan. 27 that it lost $22.2 million in the fourth quarter of 1998, twice what it lost the year before, investors drove its stock price up 9 percent. They were overjoyed the firm didn’t lose the $28.5 million many analysts had expected.
Why are investors using untested measures to justify hundred-dollar-plus stock prices for unprofitable firms?
“If the sector is hot, you latch on to anything you can” to justify buying into a stock boom, said David Menlow, president of Millburn, N.J.-based IPO Financial Network, which projects probable premiums and prices on initial public stock offerings.
Menlow, who thinks the hot Net stock market is in for a fall, questioned whether the new math would prove useful in the long term.
“Any valuation that anybody is putting on these companies is going to have an ephemeral lifetime,” he said. “Blink of an eye, they change.”
There never has been an exact science of what stocks should cost. That’s why people buy and sell at different prices. But many analysts and investors do look to some long-revered guidelines to help compare stocks and determine whether prices are too high or low.
Most investors think stock prices should reflect the amount of money a company will probably earn in the future. So one of the most popular guidelines is the price-to-earnings ratio, or P/E, which compares a company’s share price with its earnings per share. High ratios signal a high price or the need for a company to make huge profits in the future to justify its current stock price.
For example, let’s take a look at some figures from the first month of this year.
Shares of Eastman Kodak Co., which is included in the Dow Jones industrial average, closed at $65.38 on Jan. 31. The firm earned $4.30 per share in 1998, for a nice, sedate ratio of 15.2. Meanwhile, the hot stock of Microsoft Corp. had a P/E as high as 68.09 on Jan. 31, a level that makes some analysts uncomfortable.
Hot Internet stocks are off the chart. eBay Inc., which runs an Internet auction site on the Internet, has a ratio of nearly 2,000, suggesting an earning potential some 100 times greater than Kodak’s. Shares of eBay, which made its initial offering of stock at $18 in September, closed at $277.63 on Jan. 31
Other traditional stock-picking guidelines make Internet stocks look like a $50 cup of coffee. Take book value, a measure of how much stuff a firm owns–its assets minus its debts and other liabilities.
High-asset plane builder Boeing Co. has a book value of $12.97 a share. With its stock closing at $34.69 a share on Jan. 31, its price was only 2.7 times higher.
Meanwhile, Amazon.com has a book value of $1.14 a share. Its price was nearly 103 times greater as of its Jan. 31 close of $116.94.
These numbers make many traditional investors call the Internet stock phenomenon a bubble that’s bound to burst. But others say the traditionalists just aren’t counting the true value of Internet companies.
“You do not invest in these stocks thinking, `If they liquidate, I’ll get 70 cents on the dollar,’ ” said economist Ray Perryman. “What you’re investing in is a chance to make money in the future.”
Added Johnson, “The argument is that this is a new way of doing business. You’ve got unlimited potential.”
That argument makes some willing to invest almost unlimited sums in any Internet-based company on the chance it will follow the Net to glory and profits. This heavy demand is one factor driving up stock prices, because many Internet firms have few shares available.
In such an environment, how do potential investors decide whether Internet search-engine operator Lycos Inc. is a better buy at $137 than rival Yahoo Inc. at $354.25?
That’s where the new math comes in. For firms with no profits, many investors hope for decreasing annual or quarterly losses, assuming profits will some day follow, preferably before bankruptcy.
Other Net stock fans focus on year-to-year growth in sales or in the number of customers served. Increases in those measures should translate into big market share, the thinking goes, and later to profits.
Companies are feeding this trend by spending huge amounts on marketing, at the expense of profits, to generate customers. Amazon.com, for example, had sales of $610 million last year and spent $133 million on marketing–more money than it lost in 1998.
When Internet-based firms offer stock now, Menlow said, “fewer of the companies are talking about what their terminal values are going to be, and more are spending as much as they can” marketing themselves to generate customers and sales.
Some Net investors have settled on truly unusual value measurements. The ratio of a company’s market capitalization to its number of users is being used to compare hot Web firms and see whose users are more “valuable.”
Lycos, which has a market capitalization of $5.9 billion, attracted 26.4 million users in December, according to the New York firm Media Metrix. That makes each worth $223. Yahoo had 27.4 million users, valued at $1,265 each, nearly 6 1/2 times as much.
There’s no telling whether either value has any real significance; it’s just a relative measure.
Another relative measure is sales per employee, a guideline meant to compensate for a firm’s lack of physical assets. “You’re looking, really, at the intellectual capital that a company has,” said University of Washington management professor Suresh Kotha, who has studied Amazon.com and other high-tech firms.
This tool pegs Yahoo at about $527,000 per employee, about four times Lycos’ $123,000 a worker.
One problem with these new yardsticks is that none is the same length. And no one knows whether they can predict which of the fast-changing Net stocks and firms will still prove valuable in a month or a year.
“It’s clear it (the Internet) is going to grow. But it’s not clear how many of these players are going to survive,” Kotha said.
At this point, “there is no framework” for measuring, he said. “I think it’s still an art, because you’re looking at more intangibles and the longer term.”
And while looking at revenue or employment figures might be interesting now, in any case, “ultimately, it all has to come back to making profits,” Kotha said.
