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You Can't Become Rich In Your Pocket Until You Become Rich In Your Mind | ||||
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Investors seemed willing to pay virtually any price for Internet stocks, causing Federal Reserve chairman Alan Greenspan to warn of a lottery mentalityInternet investing During the second half of the 1990s and into the early days of the new millennium, investing in the Internet and investing via the Internet became the new investment frontier. The potential impact of this new communications medium on business and society was reflected in a frenzy of speculation in Internet stocks, driving prices to extraordinary levels. Much of the speculation came through online trading; the Internet enabled the emergence of the electronic day traders, who took advantage of the wealth of online data available and the low transactions costs of online brokers to place very short-term bets on stock price movements. Wilshire Associates, which manages the Wilshire 5000 index, a yardstick that includes all of the seventy-four thousand publicly traded companies based in the United States, calculated that Internet stocks were responsible for a fifth of 1998s market gain. The big-name Internet companies like Yahoo!, Amazon, and Netscape made three- or four-digit percentage gains that year. And NASDAQ, home of the markets hottest technology stocks, made its third biggest annual gain since being launched in 1971. By early 1999, investors seemed willing to pay virtually any price for Internet stocks, causing Federal Reserve chairman Alan Greenspan to warn of a lottery mentality. A year later, such warnings finally became reality as the market for Internet stocks crashed along with many other stocks in the technology, media, and telecommunications sectors. The excesses of the dotcom bubble arose in part from overblown expectations of the likely impact of the new technologies on businesseven mild skeptics at that time were told they just didnt get it. But while the claims of a new economy may have been overdone, the subsequent crash does not imply that the Internet is no longer a significant force. Dotcoms may not be taking over from the so-called legacy companies of traditional industry sectors, as many predicted, but the world has undoubtedly changed. For the securities industry itself, the Internet has helped to democratize the investment process by providing widespread access to even the most specialized data and thus leveling the playing field for individual investors. Many freely available websites display real-time stock quotes, and chat rooms provide forums for stocks not widely followed on Wall Street. There are now ways of getting information on companies, countries, regions, peoples, and cultures that were, until only very recently, totally inaccessible. Internet Investing Guru: Geoffrey Moore The Technology Adoption Life Cycle, a model developed in the 1950s by Everett Rogers, describes how a new technology gets taken up by consumers. It explains how high-tech markets go through five phases as a new technology is adopted in turn by innovators, early adopters, the early majority of users, the late majority of users, and the laggards. Geoffrey Moore, president of the Chasm Group, a high-tech market strategy consulting practice based in San Mateo, California, has extended this concept into marketing in the era of the personal computer and the Internet. He adds the key insight that there is no smooth progression between the different stages. He has also applied the idea to the business of investing in high-tech companies. Moores first book, Crossing the Chasm, introduces the idea of a gap or chasm that innovative companies and their products must cross in order to reach the lucrative mainstream market. He provides guidelines for adjusting market development and marketing communications strategies to ensure that products are positioned to break into that market. The sequel, Inside the Tornado, explores how to capitalize on the potential for hypergrowth beyond the chasm, an ambition that demands radical shifts in market strategy. The Gorilla Game, Moores third book, coauthored with Paul Johnson and Tom Kippola, combines the market analysis methodology of the earlier books with stock valuation models to suggest how to build a solid investment strategy around purchasing and holding the stocks in what the authors call gorilla companies. It is distinguished from more general growth investment books (see Growth Investing) because it focuses exclusively on high-tech, specifically on product-oriented companies that sell into mass markets undergoing hypergrowth. Moore claims that above-average returns can be made by investing in high-tech companies that own their markets and are therefore worth more than traditional Wall Street accounting allows. Moores basic story is that the way markets adopt certain kinds of technologies ends up catapulting a single company into an extraordinarily powerful and enduring position. These companies are called gorillas, and the key for successful investors is to learn the difference between gorillas, chimps, and monkeys. Gorillas are the companies that come up with the standard architecture, such as operating systems, whereas monkeys offer compatible products. Chimps are companies that tried to be gorillas but their architecture was not selected by the market. The essence of the game is to buy a basket of stocks in all potential gorilla companies. As the gorilla emerges, sell off the rest of the basket and hold the gorilla stock for the long term, selling it only when a new technology threatens to eradicate its power. Moore argues that the significant appreciation in gorilla stocks is directly linked to the periods of competitive advantage they enjoy and that far outreach their competitors. Counterpoint In 1958, fiberglass boat stocks were the hot thing on the stock market, and Dean LeBaron was the worlds greatest expert on them. At that time, fiberglass was going to wipe out wooden boats completely; it was indestructible, light, and leakproof, and it required very low maintenance. Furthermore, from the standpoint of the builder, you could pay about $300,000 for a mold and $50 for what you put in it, and then stamp out as many boats as you liked. Fiberglass fit with the leisure-time theme of the late 1950s. It fit the manufacturing notion of high fixed costs and low variable costs. Everything was right. And, of course, there were not very many fiberglass boat stocks: Glaspar, Glastron and American Molded Fiberglass were the big names. Forty years later in late 1998, Internet stocks were similar to fiberglass boat stocks. Yes, the arguments were strong. Yes, there were high fixed costs and very low variable costs. And the technology did some wonderful things and fit into some major themes. But who remembers the fiberglass boat stocks now, forty years later? And who will remember the Internet stocks of the late 1990s, forty years hence? Another more recent analogy for the boom and bust of investing in the Internet is the experience with emerging markets in the first half of the 1990s. With emerging markets, investors felt the same excitement of discovery that Internet investors experienced in the latter half of that decade, together with the glamour of seemingly unbridled growth and almost infinite demand. Investors were attracted to emerging markets because little was known about the risks or any of the eventual outcomes. This changed dramatically after the Asian crisis of 1997-1998, and these markets are now going through a period of increasing maturity and sobriety (see Emerging Markets). Getting a real understanding of how Internet technology will develop is very difficult, and during the bubble years many investors seemed not to be looking very hard at the revenues of companies whose stocks they were bidding up. Indeed, many seemed to believe that picking a few winners in a bull market, especially risky high-tech stocks, was a certificate of brilliance in investing. Long before the Internet stocks crashed, Marc Faber, our guru for Manias, Panics, and Crashes, pointed out that the most dangerous moment in any market boom is when fund suppliers stop paying attention and take, on trust, the value of the assets they are funding just because everyone else is doing it. Whenever it is expensive to monitor the value of assetsbut the opportunity costs of missing out on an investment appear too high to resista switchback effect occurs; investors stop monitoring the underlying value of the assets and look for reassurance in momentum and herd behavior. Normally, companies in an early and rapid stage of growth have difficulties financing it. Requirements for working capital, expense burn rates, and the discipline of optimistic forecasts used to attract financing all put pressures on the financial side of rapid-growth companies. But not in the early days of the Internet: Growth of customers, not necessarily revenues, brought opportunities for early public issuance of stock (see Initial Public Offerings). Thus, companies had the opportunity to monetize the prospect for revenue growthmonetize the top lineeven before the growth could be tested as a revenue generator and before profit margins could be estimated. There are important lessons to be learned from the subsequent collapse of the dotcoms and the general revaluation of the technology, media, and telecommunications sectors. These companies were fueled by an almost inexhaustible supply of liquidity. Financial resources were available to companies in these areas at virtually no cost whatsoever, and, in the process, an entire mentality emerged about companies increasing their market share despite having no prospects of profit. Totally untested business models were being financed, and venture capitalists would race and compete with each other to spend money, to invest in things that were presumed to be possible IPOs within a few months of their private placement. The whole process was built on speed and market share dominanceand finance was the motor that would drive the whole process. Following the collapse of these areas, finance has dried up; liquidity is in very tight supply; and the debt quality of technology companies and banks that do business with them has come into question. The process that is important now is survival, the very opposite course of engagement by these companies during the last decade. It seems likely that the lessons these companies have learned about cutbacks and operating at 40 percent to 50 percent lower revenues will be worthwhile for other businesses. And after operating with the notion that finance could be taken for granted, conditions have now reached the point where finance may well be in the primacy and will set the tone for business. Survival could well be the mantra for the next few years in a climate of tight finances. Where Next? The Internet is becoming increasingly deeply embedded in our daily lives. Some of its fastest growing uses are the commercial, wholesale, and retail transactions of e-commerce. These are empowering consumers in a number of ways: Advertising can be customized and directed at people who will actually find the products interesting; the purchasing convenience is tremendous; and comparison shopping becomes easy. Intelligent mobile agents or bots, a new form of computing ideally suited to the heterogeneous nature of the Internet, will become increasingly important. These are programs that act independently on our behalf. For example, a bot searching for airline tickets from virtual travel agencies on the Internet can match preferred dates, $price range, class of travel, and other features of the journey, without having to come back to us for approval. Bots equipped with some negotiating skills can be used to schedule meetings, participate in online auctions, and trade in financial markets. Library research previously depended on proximity to a well-stocked set of library shelves. And it was next dependent on your research resource skillshow good you were at retrieval, sorting, copying, and summarizing. Not now. It is possible to assign a bot a research task, which it will tirelessly pursue 168 hours a week, no fringe benefits required. And in theory, you could have many, many bots working for youand perhaps a bot to manage the bots. Once someone becomes moderately adept at research and commerce on the web, a web addict is created. At that point, it is difficult to imagine going back to the conventional practice of looking for something through the Dewey decimal system or actually to walkor drive in the case of the United States to a store. Bots may also diminish the importance of branding, which we are accustomed to thinking about in a world where information is scarce. With the Internet, information is not scarceoverwhelming perhaps, but not scarce and the power of brands and portal websites may be reduced. What is more, with new technology-like agents, it may be increasingly difficult for companies to get the lock-in competitive advantages that the gorilla game strategy demands unless they are builders of the Internet or their customers are other businesses. And the empowering nature of the Internet may well threaten the margins of even those companies with large market share. So is the Internet primarily a spoiler of profits in industries or a net builder of profit for its industry and a breeder of new industrial applications? We can see some of the areas that it will spoil: Brokers are being replaced by online financial services; e-shopping is taking over though, curiously, it is not producing any more profits for the vendors; and mail is being threatened. We do know that some new industries will come, but we cannot really see what they are. It may well be that the ease of entry into the Internet is so great that none of the companies will make any money by it. After all, we compare the Internet with the printing press and we know that the printing press put an awful lot of monks and scribes out of business. It seems likely that investing online will continue to expand and go far beyond the speculative world of the day traders. But what impact will it have on traditional financial services? Wall Streets brokers, for example, are facing a considerable challenge as they try to deal with online discount brokers. Bill Miller, our guru for Active Portfolio Management, comments: I think the online market is like the discount businessit just further segments the market; it doesnt replace traditional trading or brokerage. Sort of like TV to the movies, then VCRs, etc. Online traders are most like traditional discount customers, which is why Schwab is so successful at it. The do-it-yourself market is big and growing in a lot of industries, but it rarely if ever totally displaces those who want to pay for service and advice. This is different from, say, book retailing, where the best customers of Borders are the best potential customers of Amazon. The best brokerage customers, equity-oriented wealthy families who use margin, are not the profile of the Etrade customer, whose demographics are entirely different. They may merge in a generation or so, but by then only the most dimwitted brokers will not have been able to adapt. Finally, what is the worst economic news of the early years of the new millennium? Is it the fact that telecommunications has expanded its capacity well beyond demand? Is it the fact that telecommunications equipment, which is rapidly depreciating in terms of technology, is mostly on the books for a debt that will be difficult if not impossible to repay? Is it the fact that, though the signs of economic slowdown abound, consumers continue to march forward ignoring the signs that savings may be a good idea? A new candidate for the worst news is the report that Internet traffic may be slowing or even declining somewhat. We would certainly have expected that the Internet, which has been the driving force in the transformation of a number of companies and the development of a number of new industries, would continue to abound throughout the next cycle. Instead, the first few indications are that a decline is in order. For something as powerful and so laden with change as the Internet, this is indeed unexpected, and it is news that should cause a great deal of concern. Read On In Print Stephen Eckett, Investing Online: Dealing in Global Markets on the In ternet (Financial Times Pitman Publishing, 1997). Geoffrey Moore, Crossing the Chasm: Marketing and Selling Technology Products to Mainstream Customers (HarperBusiness/Capstone Publishing, 1995). Geoffrey Moore, Inside the Tornado: Marketing Strategies from Silicon Valleys Cutting Edge (HarperBusiness/Capstone Publishing, 1995). Geoffrey Moore, Paul Johnson, and Tom Kippola, The Gorilla Game: An Investors Guide to Picking Winners in High Technology (HarperBusiness/Capstone Publishing, 1998). |
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