The High Priestess Speaks
The Internet is so big and growing so fast — the profit potential is nearly infinite. This argument, which could be made for China as well, is used to support high price-to-sales ratios for Internet companies. But the numbers never quite make sense.
Let me interrupt myself to point out that you and I are probably both getting tired of this discussion. Internet stocks are at lunatic highs. But most of them will be less high in the future. There is probably little need to say more. We will watch and wait. Giggle and guffaw. Wonder and gape. And Mr. Market will do what he wants.
But I happened upon an interview with the high priestess of the Internet cult in Barrons which triggered a look at the whole delusion from a new angle.
“At some point in the next 5 to 10 years, 3% to 5% of GDP will be related to e-commerce,” says Ms. Meeker. This is not at all hard to believe, since “related to” can spread a long way beyond the actual Internet stocks. Even our publishing business, which uses email and websites, could be said to be at least a remote cousin, once or twice removed, from e-commerce.
But the Internet sector is already valued as though it were more than 6% of GDP. The entire stock market capitalization is about $15 trillion. Internet stocks have about $1 trillion of that. And GDP is about $10 trillion. So, roughly, the Internet sector is valued as though it were 1/15th… or about 7% of GDP.
Mary Meeker sees no problem, but the whole sector is way ahead of itself. Who would pay $1 for something that may be worth $1 in 5 to 10 years?
Meeker believes that “90% of the Internet stocks are overvalued and that 10% of the companies are undervalued — dramatically undervalued… The question is, which 10%.” She has no way of finding them. So, she merely focuses on the frontrunners — AOL, AMZN, and Yahoo. These stocks did very well — for a time. But they are, alas, the very stocks that are most likely NOT to be the big winners of the future.
Let us say her 90/10 concept is correct. Among the 300 Internet companies, 30 will be winners. The others will be losers. If this is true, any investment you make in the Internet sector should be viewed as a 10 to 1 long shot. Accordingly, you can rationally pay up to one- tenth of what you think the stock may be worth, discounted further by the time it will take to reach success.
But the well-known Internet companies are priced as though they were already winners. In fact, they are priced at such high levels that it has become almost arithmetically impossible for them ever to justify their share prices. As pointed out here a few days ago, they would have to achieve the highest levels of profit growth ever recorded… and continue to do so forever!
We would all like to find the one Internet company in 10 that will be the big winner. But at today’s lush valuations, it is almost impossible. The one that will justify its price is the one that has not yet attracted surplus capital — the one you haven’t yet heard about.
A recent issue of “Personal Finance” looked at the numbers too. It reported that the information technology sector trades at “a P/E 3 times projected growth rates.” This implies that they expect elevated growth rates for a long time. After 10 years, at these rates of growth, 60% of the economy would be IT, assuming the rest of the economy continues to grow at about 5% annually. The trouble is, IT is currently much less than 10%… and it is only growing at less than 10% annually — not the 30% the P/E rates suggest. In short, any way you look at it… the numbers just don’t hold up.
Mary Meeker doesn’t concern herself with these issues. She has faith. She is the Internet Priestess, high on AMZN, AOL, and Yahoo, of which she says, “I believe they will be three of the greatest brands we’ve ever known.”
Maybe they will. But their share prices will collapse first.
Paris, France January 27, 2000
PS. Investors entertain high hopes for the Internet, but it was only a few years ago that many entertained similar hopes for China. You may recall the arguments – – “China has 1 billion people, if only one out of 100 of them buys a washing machine… we’ll sell 10 million of them!”
China shares seemed headed for glory until 1997… when they fell by as much as 75%. Investors then forgot about the Red Chips and thought only of Rocket Chips.
But Doug Casey and Marc Faber recently reported on the changes going on in China. I’ll have more to say on this subject tomorrow — leaving the Internets to take care of themselves, as promised.
P.P.S. On this day, exactly 100 years ago, the Emperor of China was deposed by the Dowager Empress.
*** Investors wandered in the wilderness yesterday. The Dow barely budged, despite a large volume of trades. But the Nasdaq, launching pad of the Rocket Chips, fell 97 points. They seem to have lost their upside momentum this year.
*** What is happening, I believe, is that the “moment of truth” is showing up as a kind of rounding top in the market. It is gradually dawning on investors that their expectations are unrealistic… if not hallucinatory.
*** The smart money is already ahead of the trend. Bonds rose… and the techs and nets fell yesterday. Smart investors are moving from risky investments to safety.
*** There were actually more stocks going up yesterday than going down. But the number hitting new lows was three times the number hitting new highs.
*** Personal bankruptcies in Japan are up 50% from 1997. In the land where people used to pull out their own intestines to atone for financial or business disgrace, 110,000 people went belly up. Nothing like the number who do so in the US, of course, but an almost unbelievable number for Japan.
*** Retail sales have been falling for 3 straight years in Japan. Wholesale sales have been going down for the last 8 years.
*** But, as Bill Clinton will tell us in tonight’s address, the State of the Union in America has never been better. Consumer confidence has never been higher. In fact, the last time it came near to this level was back in 1968 — the last year of the Nifty Fifty bubble.
*** Everybody is learning to THINK POSITIVE in America. Even my old friend Mark Skousen tells readers that the “Nasdaq will surpass the Dow,” in his current issue. He cites the “rapid pace of productivity increases” as the reason for (almost) unbounded confidence in the future.
*** The productivity increases Mark notes are mostly an accounting fiction. But who am I to want to rain on this parade? Mark tells us that Warren Buffett lost a third of his wealth last year… because “he made a serious blunder.” He didn’t invest in the Internet. “It’s not that tough, Warren,” says Mark, encouragingly.
*** Mark also tells us that the old-economy stocks — such as the auto stocks — won’t do well. While, “there will be more records on Wall Street, biotech will continue its torrid pace, and NASDAQ will hit more highs.” I will not hesitate to remind readers that this is the same Mark Skousen who ridiculed my warning that the Japan market was about to collapse in 1988!
*** What is it that makes Japan an economy that can’t do anything right… and its American counterpart one that can do nothing wrong? Would it be too negative of me to suggest that perhaps the difference is cyclical or perhaps episodic… rather than absolute and permanent? And that the day might come when the Japanese are once again on top of the world… while Americans are the ones whose guts are twisted?
*** The best bet for year 2000 is CONVERGENCE. Sell the Rocket Chips and buy GM. Sell the Internet and buy Owens Corning…or builders… or oil companies. Sell the New Economy and buy the Old. Sell Wall Street and buy China, Russia and odd-ball, underpriced markets. Sell the dollar and buy gold. Sell dear. Buy low. It doesn’t work all the time… but no one has ever come up with a better formula.
*** Qualcomm fell 16% — down to 124. Amazon fell too. Microsoft closed below 100 — look out.
*** Rick Ackerman notes that Merrill Lynch soared 13 points in the last 2 days. But the company “faces increasingly vicious competition from a variety of sources.” Rick expects it to trade at less than $10 in the next cyclical trough.
*** “Prices rising in Europe” — the Herald Tribune tells us. And the hydraulic lift beneath consumer prices is oil — which is up nearly 200% from a year ago. Everyone says the price of oil doesn’t matter anymore. Don’t believe it. The modern economy still runs on petroleum products.
*** The Euro hit parity with the dollar yesterday… and briefly fell below the $1 mark, as I predicted several months ago.
*** What King or Queen was ever arrested for drunk driving? I don’t know, but in 1998 alone one out of every 5 members of Congress was stopped for DWI — if you believe the message making the rounds on the Internet. 117 members bankrupted at least 2 businesses. 71 can’t qualify for the credit card that is routinely offered to your dog. 8 have been arrested for shoplifting. 14 on drug charges. 3 for assault. And 7 for fraud. Clearly, the police are not doing their job. Almost all of them should be arrested for fraud. And the punishment? The guillotine was good enough for Louis XVI… it should be good enough for the Princes of the Potomac.