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Analysis: Do yourself a favor and buy Internet stocks

There's no question that Internet stocks have been brutalized in the past month and probably will continue to slide for the next couple of weeks. But for all you Johnny-Come-Latelys who cried when Amazon.com was trading at more than $400 a share, now's your chance to get into the game.

Even Frank Sinatra, who undoubtedly was more of a Philip Morris or Circus Circus man, would tell you: The best is yet to come.

An unfortunate confluence of disparate events have sent Internet stocks into a prolonged slump in the dog days of this second quarter. Individually none of these issues are terribly alarming, but mixed together and served with the garnish of knee-jerk media overreaction, it's no wonder investors are bailing out like lefties facing Randy Johnson for the first time.

So let's debunk the myths and separate fact from fiction.

Myth: The Internet bubble has burst so get out fast.

If anything the market just has too much soap in it. With all these Internet IPOs-some more dubious than others-- hitting the Street, there's simply too much supply right now. As the market sorts out the winners and losers, it's only going to improve the value of those left standing.

Meanwhile, the leaders, guys like AOL, Amazon.com, Yahoo! and eBay will flourish.

"We continue to believe that the highest-quality Internet stocks will make good long-term investments," said Henry Blodget, Merrill Lynch's Internet guru. "As the last few months have made clear, however, the sector's near-term volatility is brutal. To minimize its impact, we continue to recommend that investors buy and hold a small basket of the leading stocks over the long-term."

Yes, some of these same leaders are the ones that have taken the brunt of the fall of late, but let's take a closer look at just how bad things really are.

Inktomi Corp. (Nasdaq: INKT) was off 6 5/16 to 97 Tuesday, a far cry from its 52-week high of 159 1/8 set in April. But year-to-date, it's up 59 percent. CNet Inc. (Nasdaq: CNET) was off 8 1/16 to 107, down from its high of 159 ? last month but up a whopping 467 percent for the year.

For all you purists who believe in buying proven technology companies with reliable earnings, consider that Cisco Systems Inc. (Nasdaq: CSCO), arguably the best stock in the world in the past five years, is up only a few bucks a shares since the beginning of the year. And Intel Corp. (Nasdaq: INTC) is actually down a few bucks, trading at 54 7/16.

Myth: Internet valuations are too high.

This argument might have made sense if these Internet stocks had just hit the scene. But we're quietly approaching the two- and three-year mark for most of these guys and they're still trading at unfathomable P/E ratios. In fact, most don't even have the earnings to qualify for a price-to-earnings ratio.

"I find the valuation argument as a catalyst for the reversal of these stocks very interesting," said Bruce Smith, an analyst at Jefferies & Co. "If that's true, then when weren't these stocks overvalued? Two months ago? Six months ago? That's a pretty weak argument."

Keep in mind, this isn't your father's stock market anymore.

Quietly, Cisco's P/E has sauntered up to 94.2. Lucent Technologies Inc. (NYSE: LU) is at a fat 78.5. So is AOL such a tremendous risk at 239?

Myth: Internet stocks are heading into a summer swoon.

Yes and no.

Most of the recent declines can be partial explained by the lack of news and events during the summer months. No stocks thrive on news more than Internet stocks and, frankly, no one wants to spend their free time online during the seductive summer months.

That means traffic will decline, not to the point of regressing below the year-ago periods, but it won't provide that "wow" factor when sequential traffic jumps 60 or 80 percent in a quarter.

But things appear especially bleak in May for Internet stock because the second month of the second quarter is typically the low-water mark in any given year.

"We still expect to see at least a modest rally in the sector in June," Blodget said. "We do not expect the leading stocks to hit new highs, but our guess is they will trade higher than current levels."

Blodget also points out that now's the time to buy these leaders which are trading at 30 percent to 40 percent lower than their highs. It's happened in each of the past four quarters and guess what? They all rebounded to new record levels.

Internet stock also have the admirable quality of enjoying their best run-ups in the third quarter after reporting their second-quarter results. Most of that excitement is based on strong advertising revenue which tends to peak in the second and fourth quarters.

Myth: The Internet leaders in such peril right now.

Indeed, the big boys in this sector are facing some issues that have raised some doubts in the investment community.

At the top of the list is AOL, which some fear will fall behind the cable companies in delivering online services. Nothing brought this to investors' attention more than the merger between AT&T (NYSE: T) and MediaOne.

But AOL's content to let that slip by, building on its theory that since no one really knows what technology is going to take over it's best to have all the possible options ready for deployment.

With Amazon.com, you've got a company that's growing so fast and trying to do so much that it's going to have a difficult time doubling its sales every quarter.

Instead of going gangbusters for that extra 5 or 10 percent in revenue, Amazon.com is building distribution centers and buying companies that improve the value of its existing core business.

It means the stock isn't going to get that huge surge on blowout earnings and sales improvements, but it just might grow into its enormous valuation.

Yahoo! Inc. (Nasdaq: YHOO) keeps delivering solid earnings, traffic and sales figures in every quarter, but some people are worried that it will have trouble integrating both GeoCities and Broadcast.com Inc. Maybe it will.

But given Yahoo!'s track record, who'd want to bet against them?

Myth: The bull market's coming to an end

That alone should convince investors to get back into Internet stocks. About every six months, some "expert" gets on CNBC and predicts a 20 percent pullback in the market. And about every six months, that same guy comes on and predicts another pullback.

Nine years and counting and we're still in the midst of an incredible bull run. Moreover, what can these investors do with all the money they've made in the past nine years? Buy T-bills?

This market, allowing for natural ups and downs, might never see a true bear market again.

When the New York Times claims the bear market has arrived, as it did this week, and Ralph Acampora, a Prudential Securities analyst famous for missing the mark on his bearish calls, tells the world to sell Internet stocks, it's time to start buying.

But what's a market without worry.

In a couple months, we'll be reading and writing stories about how dangerous these high-flying Internet stocks have become after they go on another torrid run.

Do you want to be reading about these tremendous run-up as you're holding the stocks or do you want to be worrying about finally getting in on some of these future bellwethers?