Internet Stocks: Are We Having Fun Yet?

Unless you've been living in a cave for the last few years, you've been unable to escape the seemingly endless discussions in the financial press about the rise and fall (and rise and fall and rise and . . .) of the "dotcoms." Here are a couple of tidbits you may not have heard of yet, though.

The parlor game of the late '90s is, of course, how to value 'net stocks. Among the questions you might wish to raise with your students are the "nuts-and-bolts" issues, such as:

(1) Do the traditional valuation metrics apply? What relevance does P/E have in a world where the firms with the largest market cap have yet to generate positive earnings?

(2) On a broader scale, ask them to consider how the role of the traditional metrics (which were developed for use in analyzing "smokestack" firms at the dawn of the industrial age), in the information age and the world of the virtual firm. (Tip: For some interesting reading on the societal impacts of the paradigm shift we are living through, see "The Electronic Economy" in the December 14, 1998 issue of Forbes, and "The New Logic of the Company" in the November, 1998 issue of Fast Company.)

(3) Then, ask your students to reflect on the interrelationships between the traditional (some would say "moss-encrusted") notion of the corporate life-cycle extending over decades of growth, development, maturation, and decline of the hypothetical firm, and the phenomenon of "internet years." (One writer has suggested that a good rule of thumb is that an internet year is like a "dog year" -- an internet firm goes through in one year what a "traditional" firm goes through in seven years. Don't believe me? Consider timing of the rise and fall of Netscape!)

(4) Finally, point out to your students that practicing security analysts have developed a new approach to valuing 'net stocks. For example, tech stock analysts at Edward Jones in St. Louis use differnt metrics, depending on the stage of the life cycle the firm is in. During the initial growth spurt, they focus on ratios such as sales-to-cash flow, and sales per employee, ignoring earnings-based ratios altogether (since earnings are generally scarce). As the firm "matures" (that is, survives past, say, 6 months), they shift their focus to market penetration, managerial skill, etc. Finally, it is only when the firm starts to reach the profitability stage, that they begin to use more traditional measures.

Students generally have a lot of experience on the 'net, and using 'net stocks to illustrate corpfin concepts has been especially useful to me. I think your experience will be similar.

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