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Net stocks defy Street smarts

Stock buyers who adhere to old-school rules are left behind by the incredible run-up in risky technology and Internet stocks.

3 min read
Stock buyers who adhere to old-school investing rules are being left behind by the incredible run-up in risky technology and Internet stocks.

The bull market has propelled some Internet shares past the psychological $100-a-share mark, prompting some companies to announce stock splits before their first birthdays. This week alone, both Excite and Yahoo! reached new 52-week highs, and Amazon.com today topped the $100-per-share mark, despite having split its shares barely two months ago.

The euphoria is being driven by the technological revolution and high-tech's growing influence in the economy. "What we're talking about is not a passing fad," said Gary Craft, an e-commerce analyst for BancAmerica Robertson Stephens.

As a result, analysts and investors are rewriting the rules for choosing many stocks, with strategies based far more heavily on promise than on proven track records. Whether they will succeed remains to be seen.

"Just showing profitability is no longer the only criteria in choosing an Internet stock," said Andrea Williams, an analyst with investment banking firm Volpe Brown Whelan. "Investors are willing to invest in Internet stocks and to wait while [the stocks] establish market recognition."

Williams added that a company's success also can be measured by steadily growing revenues and market share from quarter to quarter, even if it remains unprofitable.

"This type of investor is much more growth-oriented. It's the age-old risk-reward formula, where higher risk should deliver higher reward," said Jim Pickrel, an analyst following the enterprise application and data management sectors with investment banking firm Hambrecht & Quist. "These [Internet stock] valuations are based on forward revenues--investors are forecasting on one, two, or three years out."

Pickrel's attitude is a departure from the standards of blue-chip stock investors, who "expect stability and proven profitability," Williams said.

Billionaire investor Warren Buffet perhaps best typifies the conventional Wall Street wisdom. A self-described "technophobe," Buffet is a buy-and-hold investor who sinks his wealth into Fortune 500 companies such as Coca-Cola and Gillette. His motto: Don't buy stock in businesses that you don't understand.

By his own admission, Buffet has missed out on the double- or triple-digit returns some tech and Net stocks have seen this year by standing on the sidelines. He even has foregone investing in unflappable Microsoft, run by his billionaire buddy Bill Gates. Nevertheless, Buffet's personal portfolio has generated healthy returns.

Old-school investors like Buffet remain leery of the downside of volatile stocks such as those in the Internet sector. Whether many of these stocks can maintain their sky-high valuations remains an open question.

Not that today's disregard for Wall Street's conventional wisdom is new. Biotechnology stocks once were hot despite the industry's sluggish returns--and they didn't always pan out as long-term investments.

"Those biotech companies had losses, but [offered] promises that, down the line, blockbuster deals would turn them into profitable enterprises," said Terry McCrary, senior vice president of research with investment banking firm Waldron & Company. "Internet search engines are at a similar stage right now."

Craft said the current stability of the economy puts less pressure on companies to show quick profits. "A benign inflationary environment helps companies whose cash flow is five years down the road instead of today," he said.

The booming economy even has prompted some institutional investors to dabble in Internet and higher-risk technology stocks, like Yahoo.

Still, the bulk of the Net and tech investments come from individuals. "Investors in Internet stocks will tend to be more inexperienced," said McCrary. "The big institutional investors are the ones looking for a proven track record."

But the biggest test of the staying power of these "nouveau" investors is yet to come. "This has been such a long bull run, they've never had a chance to lose money," said David Takata, an analyst with Gruntal. "And once they get a taste of that, they will retrench to those traditional market values."