Starting in late 1998, investors helped create a historic surge in tech stocks emboldened by the belief that the traditional rules of the marketplace did not apply to these stocks.
The numbers: Microsoft Corp. stock rose sixteen-fold between the end of 1994 and its high last year, powered by the belief that its software had secured a permanent monopoly. Dell Computer Corp. multiplied ninety-three-fold between the same starting point and its peak this March, on the view that it could generate astonishing personal-computer sales growth no matter how big it became. Similar arguments drove up Intel Corp. nineteen-fold and Lucent Technologies Inc. twelve-fold during roughly comparable periods. These companies, and dozens of others, propelled the greatest bull market in history. The Dow Jones industrial average jumped 200 percent from the end of 1994 to its peak in January, and the tech-heavy Nasdaq Composite Index had leapt 571 percent when it reached its high in March.
But suddenly all bets are off. The Dow Jones industrial average is down about 10 percent this year. The Nasdaq Composite Index is in the throes of a savage bear market. It has collapsed 45 percent from its March high.
Thursday, we took a look at three of the six most potent myths about tech stocks. Here’s a look at the other three.
Myth No. 4: Exponential Internet growth has just begun and, if anything, will accelerate.
J. Thomas Madden, chief investment officer at the Federated Investors Inc. mutual-fund group in Pittsburgh, a one-time skeptic of tech stocks, gradually found himself embracing the idea that the Internet would strongly influence the future of the stock market. He recalls being told by a scientist at Carnegie Mellon University that if you plotted on a chart the number of Internet users or of network parts needed, it would rise geometrically.
When an investor “begins to believe that such growth may continue for years to come, it is easier to withstand very lofty valuations,” Madden has explained.
But demand for Internet products and services, though strong, hasn’t proven infinite.
Once most companies set up a Web strategy and a home page, growth in their Internet spending tends to slow.
As the overall economy has downshifted a bit, Internet-advertising dollars have flowed less readily. Last month, the stocks of Yahoo! Inc. and DoubleClick Inc. were clobbered on signs of flagging growth in Web advertising.
What’s more, Internet companies had assumed shareholders would wait patiently for years before demanding that they show significant profits. Instead, investors are bailing out of companies that spent aggressively on attracting customers: Amazon.com Inc. is down about 75 percent from its all-time high, ETrade Group Inc. about 70 percent and iVillage Inc. about 95 percent.
The myth was “that there was no price that was too high for a good tech company,” says Ed Keon, director of quantitative research at Prudential Securities, himself a reformed advocate of high-priced technology stocks. But “eventually, there is a price that is too much to pay even for a fabulous stock such as Cisco Systems or JDS Uniphase,” makers of communications equipment used in building the Internet.
“At some point,” Keon says, “you had to ask yourself, wait a minute, is there anybody left that doesn’t have a Web site now?”
Myth No. 5: Prospects are more important than immediate earnings.
Henry Blodget of Merrill Lynch expressed the core of this myth in December, when he wrote of Internet leaders like Yahoo! Inc., “It is a mistake to be too conservative in projecting future performance.” Yahoo at that time was trading at 500 times projected profits for 2000. “The real `risk,”‘ Blodget asserted, “is not losing money — it is missing major upside.”
Today, investors are nervous about Yahoo’s slowing revenue growth, and the company’s stock is down about 70 percent since December. In retrospect, Blodget concedes that while advising investors not to be too conservative “was the right prescription for 1995 to 1998, as soon as we got into 1999, it was a mistake. Expectations got ahead of reality.” Valuing these stocks on prospects and potential size of market sometimes made analysts forget what could change, such as competition.
FreeMarkets Inc., which operates online auctions for industrial companies’ purchasing needs, went public at $48 last December. By February, when co-lead underwriter Goldman Sachs & Co. initiated coverage, it was trading at $217. Goldman analyst Jamie Friedman said that in six to 12 months, the stock would be worth between $300 and $400.
That was based, among other things, on the expectation that FreeMarkets would eventually handle 5 percent of an estimated $5 trillion in global procurement. But FreeMarkets’ potential customers saw similar opportunities and began forming their own online procurement consortia. Since February, FreeMarkets has lost 81 percent of its value. Friedman says he didn’t foresee the creation of competing consortia.
Myth No. 6: This time, things are different.
More than any other misconception, this was the most fundamental of the myths to which people succumbed. And like many of the others, what made it so seductive was that it had so many elements of truth to it.
Rarely had a series of phenomena — the Internet, wireless communications and computer networking — so quickly become such a big part of so many people’s lives. Analysts compared the situation to revolutionary developments of the past — the popularization of the telephone, radio, television and car — all of which took far longer to grab the national consciousness.
But tech fans ignored the fact that even companies involved in a revolution eventually face market forces. Most early automakers failed to survive. Radio Corp. of America and General Motors Co. were two of the hottest stocks of the 1920s, but that didn’t prevent both from crashing along with the rest of the market in 1929. RCA eventually lost 98 percent of its value.
Some analysts remain unrepentant defenders of their views on tech stocks.
Bruce Steinberg, chief economist of Merrill Lynch, says he never tried to justify the highest of the tech valuations. As for the rest of the sector, he adds, it will recover. “I think the new economy is alive and well,” he says, “and I don’t think this is the end of the story right now.”
But some money managers warn that certain tech stocks, notably in the networking and optical-fiber area, still haven’t fallen enough to reflect the real world.
Says Michael Weiner of Banc One Corp.’s money-management unit in Columbus, Ohio: “It doesn’t look to me like we have entirely learned our lesson.”
